by Calculated Risk on 3/12/2007 02:26:00 PM

For discussion, Tanta asked that I reference this chart from Credit Suisse: Segmentation of Outstanding First-Lien Residential Mortgage Debt. See page 28 (exhibit 21) here.


Note that this is First-Lien only.


Tanta will have more later today.

by Calculated Risk on 3/12/2007 12:36:00 PM

In a research note this morning, titled "Mortgage Liquidity du Jour: Underestimated No More", Ivy Zelman, et. al. at Credit Suisse wrote "it’s not just a subprime issue."

"Not just a subprime issue." More supply. Lower demand. Lower prices.

For those in the housing industry, 2007 will make 2006 look like a great year.

by Calculated Risk on 3/12/2007 11:04:00 AM

From CNNMoney: Embattled subprime lender says its lenders are cutting off financing; faces $8.4 billion in obligations.

Embattled mortgage lender New Century Financial Corp. warned Monday of a series of serious financial problems that cast its future in doubt - and cast a pall over much of the nation's financial sector.

The Irvine, Calif.-based company, No. 2 in lending to borrowers with weak credit, said that all of its own lenders are cutting off financing, that it has been found in default of many of its financial agreements, and that it does not have the funds necessary to meet its obligations under current circumstances.

New Century Financial detailed a new series of financial problems in a filing with the Securities and Exchange Commission early Monday.

In addition, the company said it does not expect to meet the March 16 extension for filing a 10-K annual financial report with the Securities and Exchange Commission.

Here is the SEC filing.

by Calculated Risk on 3/12/2007 01:29:00 AM

From the WSJ: Subprime Fallout May Not Infect Broader Market

As more financially stretched homeowners renege on their debts ... economists are surprisingly sanguine about the broader economy's ability to weather the storm. ...

... the market for "subprime" mortgages -- home loans made to people with poor or sketchy credit histories -- has unraveled with impressive speed and intensity. ...

So far, though, many economists -- including Federal Reserve Chairman Ben Bernanke -- haven't changed their forecasts as a result of the subprime troubles. ...

"No doubt some of the worst practices of the housing boom are going to yield some payback," says Steve Wieting, senior U.S. economist at Citigroup in New York. "But it's not large enough to derail an otherwise healthy economy."

It's amusing that the article quotes Citigroup, the poster child for overly optimistic housing forecasts.

... The main reason for economists' equanimity: Those who took out subprime loans tend to be less-affluent consumers who make up a relatively small share of consumer spending, the most important driver of the U.S. economy. ...

This seems reasonable if you make two assumptions: 1) the problems will stay in subprime, and 2) there will be little impact on the housing market from the subprime implosion. The first is possible, the second is not.

Then the WSJ article notes that housing supply will increase and demand will fall:

... the pullback in credit for subprime-mortgage borrowers could have a meaningful effect on its own. As some potential home buyers find it harder to get money and more bad loans beget more foreclosures, the decreased demand and increased supply of homes could depress prices, deepening the housing slump.

And what will be the impact on the economy of the deeper housing slump? The article doesn't take the next step, so I will: there will be significant housing related job losses, and slower growth in consumer spending since homeowners cannot borrow against their homes (less Mortgage Equity Withdrawal or MEW). It's probably a coin-flip if these problems will take the economy into a recession in 2007.

I'm definitely less sanguine than most Wall Street economists.

by Calculated Risk on 3/11/2007 03:35:00 PM

From the Financial Times (hat tip Name): The dream machine: invention of credit derivatives. A short except on Bistro:

By 1997, Demchak and Masters came up with their Big Idea: a product known as Bistro, short for Broad Index Secured Trust Offering. ... What Bistro did was to use credit derivatives to “clean up” a bank’s balance sheet. The scheme started by taking a basket of bank loans and separating out - in accounting terms - the theoretical risk that these loans would turn sour from the loans themselves. This default risk was usually then sold to a “paper” company, known as a special purpose vehicle, which then issued bonds that investors could buy. ... And as long as the deal was structured in a way that made the bonds look cheap, relative to the risk of default, then investors would think they had got a good deal. The pricing itself was based on what had happened to banks’ loan books in recent years (together with some complex number crunching).

The deal looked even better for the original bank. For the act of selling the default risk on to new investors had crucial regulatory implications. International banking rules say that banks have to hold a certain level of spare funds (or reserves) to protect themselves from the danger that their loans might turn bad. However, since the banks had sold the risk of default on to somebody else, they could now argue that they did not need to hold these funds.

To anybody outside the world of finance, this might look odd (after all, the banks were still making loans); but the regulators accepted this argument, since the risk had moved, in accounting terms. And that let the banks free up funds to make even more loans. It was the financial equivalent of calorie-free chocolate: almost too good to be true.

by Calculated Risk on 3/11/2007 03:46:00 AM

First, here are two very different stories ...

From the LA Times: Businesses pinched as commercial rents soar in Southland

Sizzling demand for offices, warehouses and retail space is hitting Southern California and other major urban centers. ...Office rents have climbed more than 25% on average in the last three years in much of Los Angeles County.
...
Vacancies have plunged to well below 10% in many areas, making it harder for businesses to find space. Only 3% of the region's industrial space — used for warehouses and factories — is available, a level that is considered drastically low.

And from the Press-Enterprise: Office-space surplus plagues Coachella Valley

The Coachella Valley has too many offices for too few employers willing to rent them, but that hasn't stopped developers from planning projects with more than 1 million square feet of office space ...

Brokers said up to 23 percent of the offices in the Coachella Valley are seeking renters or buyers. A healthy office-building market occurs when vacancies are less than 10 percent.

In some areas, commercial space is clearly limited. But in most of Southern California, and in many parts of the U.S., there is a commercial building boom occuring right now.

This should be expected. Historically non-residential construction follows residential construction. In an earlier post, I graphed the investment lags for non-residential investment compared with residential investment. Here is the graph:

Click on graph for larger image.

The highest correlation for non-residential structures is a lag of 4 to 5 quarters. There is a positive correlation for other periods also. For non-residential structures, a lag of 5 quarters would suggest the YoY change would turn negative in Q3 2007. Update: The seasonally adjusted annualized change in structure investment was a negative -0.8 in Q4 2006.

This second graph shows the CRE delinquency rate vs. private non-residential construction spending. In the previous commercial real estate (CRE) slowdown, the delinquency rate started rising a couple of quarters before construction spending slowed.

The delinquency rate is rising again, although this time from a much lower level. This could be an indication that non-residential construction spending is about to peak.


And the third graph shows non-residential construction employment. Note: graph starts at 3 million to better show the change.

Non-residential construction employment has been flat for about four months, after a significant increase in employment in 2006. This might be another indicator that CRE investment is peaking.

This might be a story later this year: the start of a commercial real estate bust.

by Calculated Risk on 3/10/2007 11:54:00 PM

After reading the comments in the previous thread, I'd like to caution about generalizations. It's easy to pick out the mistakes, like this WSJ article at the peak in July 2005:

Neil Barsky writes in the WSJ "What Housing Bubble?"

If you want to be scared out of your wits these days, you basically have two choices: go watch Steven Spielberg's latest, or listen to the hysterical warnings of economists and journalists about the imminent popping of our so-called housing bubble.
...
The reality is this: There is no housing bubble in this country. Our strong housing market is a function of myriad factors with real economic underpinnings: low interest rates, local job growth, the emotional attachment one has for one's home, one's view of one's future earning- power, and parental contributions, all have done their part to contribute to rising home prices.

But at the same times there were journalists asking the right questions:

Caroline Baum: Enough About Loans. What About Lenders?

Forget the borrowers for a minute. Who's making these arguably risky loans? Why are lenders extending credit to seemingly bad credit risks?

Or Danielle DiMartino: Bubble's fallout? Two views

The inevitable pullback in construction speaks directly to housing's risks. A similar 40 percent decline in construction to that of the 1981-82 recession implies a decline of 2 percentage points in GDP.

And then there's the wealth effect. The housing bubble has added $5 trillion to household net worth, equating to about $70,000 for a family of four.

And it would be easy to blame the economists. Bernanke in July 2005: House Prices Unlikely to Decline

Top White House economic adviser Ben Bernanke said on Friday strong U.S. housing prices reflect a healthy economy and he doubts there will be a national decline in prices.

"House prices have gone up a lot," Bernanke said in an interview on CNBC television. "It seems pretty clear, though, that there are a lot of strong fundamentals underlying that.
...
"We've never had a decline in housing prices on a nationwide basis," he said, "What I think is more likely is that house prices will slow, maybe stabilize ... I don't think it's going to drive the economy too far from its full-employment path, though."

But some economists were warning about housing. From Bloomberg: Greenspan Housing View Seen Hazardous by Wall Street Economists

Worry, say Wall Street economists including David Rosenberg of Merrill Lynch & Co. and Stephen Roach of Morgan Stanley.

The economists say the Fed must act, for a simple reason: The U.S. has become so dependent on real estate and construction to fuel growth and jobs that an eventual, wrenching correction has the potential to sink the entire economy.

"Act now and cut off the pinky, or wait till later and risk slicing off the entire hand," Rosenberg said in an interview last week. "Either way it hurts, but you can still type with nine fingers."

Economics Professor and former Dean of the UCI Graduate School of Management Dennis Aigner wrote in the OC Register: Trouble in housing market no game, Region's house of cards ready to topple as prices reach unsustainable levels.

Over the past four years, 90 percent of the growth in U.S. GDP was accounted for by consumer spending and residential construction. Declines in the nation's biggest housing markets are likely to trigger a major economic slowdown.

It is not a question of whether this will happen but when, how dire will be the consequences on economic growth, and how long it will take to restack the blocks and begin again.

It is easy to focus on the negatives in Tanta's post, but remember Tanta also wrote:

Let us say that we cherish those reporters who are regular readers of ours and insightful commenters on the blog, enthusiastic participants in a new medium, interlocutors rather than overlords.

And we do cherish them. Blogs are a complementary good to other media outlets, not a substitute.

by Calculated Risk on 3/10/2007 05:18:00 PM

From CR: Regular readers will immediately recognize that the following piece was written by Tanta. I'd like to add that I have an excellent relationship with several prominent reporters (you know who you are), and I look forward to continuing our offline discussions via email and phone calls. I've never sought any personal publicity, although I'd be happy if you quoted from the blog (with a reference). For those reporters hoping to have a similar relationship with Tanta, please think of Tanta as the Man in Black from the "Princess Bride":

INIGO: Who are you?!

MAN IN BLACK: No one of consequence.

INIGO: I must know.

MAN IN BLACK: Get used to disappointment.

Dear Inquiring Minds:

Calculated Risk is a hobby blog, created and maintained by a retired executive, with occasional assistance from a former bank officer and mortgage lending specialist who is currently on extended medical leave. Both of these people get endless questions, answers, hat tips, links, analysis, and overall inspiration from a very diverse group of commenters, regulars and occasional de-lurkers, all of whom are beloved except some of them.

CR regularly gets emails and comments from paid reporters who wish to know if CR or Tanta would like to be interviewed, or would simply like to answer one or several questions that the reporter has about economic or housing or mortgage issues. Because, so far, the answer has always been something on the order of “no,” we would like to explain to you why this is the case. (CR Note: I have no problem discussing general economic and housing issues offline).

Calculated Risk is a blog. That means that it is a medium on which CR, Tanta, and the commenters are free to publish the things they want to say about subjects in which they are interested and to which their expertise is relevant. It is possible that there are bloggers out there who are publishing blogs with the secret hope that they will be discovered by the Big Paid Media and get interview requests, so that they may see their names next to a short, context-free, undetailed, possibly memorable or pithy but usually just crudely-edited quote in the newspaper. Some people may have ambitions that go beyond that, such as becoming a freelancer for Big Media companies, in order that they may get paid in the high two figures to produce short, simple-minded articles that Big Media won’t fact-check any more than they fact-check anything else. There may even be bloggers so delusional innovative that they still have hopes that the Big Media, print or online, will quote directly from their blog postings and provide links (text or hypertext, as the format allows) so that Big Media’s readers can be directed to the blog for further information. It’s a big internet, we’re not all alike, and neither CR nor Tanta intends to be speaking for any bloggers other than themselves here. Suffice it to say we are not in the above categories.

Dear reporters, we quote your stuff periodically, giving credit both to the reporter and the publication, under fair use terms. We have no objection to your returning the favor. If you have an editor who will not allow that, and you think that the problem can be solved by getting one of us to drop our online personas, give you our real names, and say the same thing to you over the phone, so that you can get your editor to accept it as something other than just blogging, which everybody knows is untrustworthy ranting by anonymous nuts, you are making a faulty assumption about the relationship among us, our birthdays, and yesterday. Neither CR nor Tanta wishes to play into a set of assumptions that render what we say on the blog as unworthy of coverage by the Big Media, but what we might say on the phone to Intrepid Reporter as good dirt and straight skinny.

Do you, can you, understand the implicit insult in that? You want to talk to us because of what we have written on this blog, instead of simply engaging with what we have written on this blog. You are saying that blog entries we have written, at our own inspiration, on our own time, for our own intellectual purposes, backed up by our own research, are not good enough for you to use as source material (properly credited). It only “counts” if you get to ask the questions, form the story angle, edit the material, and put names on it. This is the message we’re getting from you, and the only reason that our answer to many of your inquiries is “no” is that we are—CR at least, is—too polite to make it “no, and go take a hike with the horse you rode in on.”

Some of you are also, if we may say so, operating out of a sense of entitlement that takes our breath away. Here is the entirety of an actual email we received from an actual reporter of a print publication (names omitted to protect the egregious):

I am working on a story about Wells Fargo and subprime lending. I am trying to determine if Wells Fargo bears any sort of risk to the subprime shakeout. You covered this topic on Feb. 16 after John Stumpf presented to the CFSB conference.

I have the same questions many of your bloggers did. What is co-issuing and does that really remove WFC from any risk from these loans?

That is the entire message except for the name and newspaper of the sender. CR and Tanta, who have both worked in large corporations for non-trivial amounts of time, can testify that we have rarely gotten emails like that even from our bosses, who were paying us in dollar-denominated instruments and therefore reserved the right to ask us to do some work. Tanta has herself received email requests for research and information from the CEO of her company that managed to include “please” somewhere near the beginning and “thank you” somewhere before the end. She has also received email requests from business associates who were not actually providing her paychecks, but who were sources of business for her company and thus part of what made her employer profitable, that included not only “please” and “thank you” but such phrases as “if you have the time” and “I realize you aren’t paid to do this, but” and “please let me know what I can do for you in return.” Stuff like that.

Let us say that we cherish those reporters who are regular readers of ours and insightful commenters on the blog, enthusiastic participants in a new medium, interlocutors rather than overlords. We hope any representative of the Big Paid Media will join us in our journey of discovery—just click on the “comment” link at the bottom of a post, make up a handle for yourself, and type away! Feel free to make suggestions for future posts; everyone else does. Feel free to share your own information; everyone else does. Feel free to get flamed if you get uppity; everyone else does.

At the end of the day, please try to understand that we’re doing this for fun. We are not being compensated except for the modest ad revenue that covers the costs of hosting the blog and doing some subscription research that pays salaries for Real Reporters. Insofar as you are sending us inquiries because you think we sound like professionals and have brains in our heads, we’re flattered. However, like you, we just want people to read what we have written. We are not here to hawk our services as comment-bots for some reporter on deadline, nor are we interested in anyone’s investment strategies. This blog is not about helping anyone else make money in the stock or bond or real estate market. Commenters are free to discuss such issues, although they are subject to being banned or having their comments edited if they appear to be disseminating insider information, or trolling for suckers to buy some product or service, or just hijacking threads to endlessly request investment advice that will not be given, unless such comments are sufficiently entertaining to the rest of us and provide useful opportunities for clever snark. The definition of “appropriate comments” is at the whim of the blog host, and there is no avenue of appeal. This guideline extends to emails sent to the blog host, which may or may not be read or answered as the blog host’s time, energy, and idiosyncratically fluctuating level of enthusiasm for reading emails allow. (CR Note: I try to read and respond to most emails) If you do not receive an answer to your email, it may be that we are simply without the time to get to it. It may be, as in the example above, that we do not trust ourselves to answer without blowing our cool in ways that are not conducive to a pleasant retirement or tranquil recuperation. Yes, this means that you are dealing with some hobbyists who really don’t care if this sounds “professional” or not. That is what we have been trying to tell you all along by our choice to be bloggers instead of professional research organizations. We apologize if our strategy was insufficiently transparent.

P.S.: If you are a Nigerian Prince, or anyone else, in need of a bridge loan in order to secure Endless Riches that you would like to share with us, please provide us with your SSN/TIN, checking account number, ABA/routing information, home address, and photographs. We promise not to share that information with anyone other than one or two acquaintances of ours at the DOJ. TIA, as we say on the blogs!

by Calculated Risk on 3/10/2007 04:53:00 PM

Gretchen Morgenson writes in the NY Times: Crisis Looms in Mortgages. This article is a must read. A couple of quotes:

"I think there is no doubt that home sales are going to be weaker than most anybody who was forecasting the market just two months ago thought."
Thomas A. Lawler, founder of Lawler Economic and Housing Consulting, March 10, 2007

I think I was more bearish than most, and even I am considering revising my forecast downwards.

“There are delayed triggers in many of these investment vehicles and that is delaying the recognition of losses. I do think the unwind is just starting. The moment of truth is not yet here.”
Charles Peabody, founder of Portales Partners, an independent research boutique in New York, March 10, 2007

by Calculated Risk on 3/10/2007 02:12:00 PM

From Annette Haddad and E. Scott Reckard at the LA Times: Loan turmoil closes doors for buyers

Many would-be home buyers, and homeowners who want to refinance, are finding that virtually overnight their status has changed: They no longer are eligible for the kind of easy-credit loans that helped millions of people join the ranks of property owners during the housing boom.

This is an excellent summary article of the events of the last few weeks. It does seem like an "overnight change"!

A key concern: whether the problems of sub-prime lenders and borrowers could drag the economy into recession by causing a broader credit crunch.

Many economists, as well as Fed officials, say they don't believe that sub-prime borrowers account for a big enough share of the housing market to have a dramatic effect on the economy.

First, the problems in the sub-prime segment alone could be large enough to significantly impact the economy. As the LA Times article noted, 21.5% of all mortgages in 2006 were sub-prime. Some estimates are that about one fourth of all sub-prime borrowers will be locked out the market in 2007. That would represent 300K or more potential home buyers.

And the problem is much worse because of the dynamics of the housing market. Each first time home buyer (and many sub-prime borrowers are first time buyers) is the start of a mini-chain reaction in the housing market. As an example, when a first time buyer buys a home, the seller buys a move-up home, then that seller buys a larger home, and that seller buys a Toll Brothers' McMansion. The loss of one sub-prime borrower may result in the loss of several sales. The loss of 300K buyers will be in, the words of Bear Stearns' Dale Westhoff, "non-trivial".

And second, the problem is already spreading to Alt-A and will probably impact many prime borrowers - especially the borrowers that used non-traditional mortgages, like option ARMs, as "affordability products".