by Calculated Risk on 4/03/2007 03:39:00 PM

From MarketWatch: Ford March U.S. sales drop 9%, GM, DaimlerChrysler post 4% declines as Toyota gains ground

Nothing new here. The auto industry is in a recession. Housing is in a depression. Capital spending is soft. But the U.S. consumer continues to borrow (more and more on their credit cards) and spend.

No wonder Tim Duy writes: Fed Still Looking Through the Slowdown – Should You?

Much of the recent data are weak, no doubt about it. Growth has slowed, plain and simple. And any optimism I see in the yield curve could be dissipated with Friday’s labor report. Or, as another Fed watcher once put it, it could be a case of Stockholm Syndrome, in which following the Fed forces you to think like them. But in any event, Bernanke & Co. are sticking to their guns, still looking through the downturn and downplaying the risk of recession. With so many ready to call the Fed wrong, it is worth thinking about the possibility that they are right.

by Tanta on 4/03/2007 08:28:00 AM

Regular readers have gotten the impression that I have spent a fair amount of time in the mortgage business. And that I have developed what one might fairly describe as some cynicism about it. One or two of you have asserted or implied that I possess sufficient written communication skills (as we call it in the corporate world) to be able to earn my keep doing something else. This makes some people wonder why I didn’t spend those years doing something else. Join what used to be the Tanta Single-Member Club.

You want to know the truth? I bought it. The American Dream. A place to call your own. Out of the cramped, noisy, expensive apartment, the shabby trailer, mom’s basement; into your own space. A room for the kids. A yard for the dog. Walls you could paint purple, if you felt like it, and hell with the landlord. A 1200 square foot elderly bungalow with a porch. You could start from there. Exposed power lines, cracked sidewalks, closer to the Krogers than the Dorothy Lane? One bathroom for three people? Old double-hung windows in need of a little paint and a little more sweat equity? No garage for the old beater? You could start from there. You could start. There was a beginning. Beginnings imply middles and ends. We were going places someday. It had to start somewhere. The first day of so many people’s futures was in my bank.

The horseshit level of life in a large bank holding company is just like anywhere else in the corporate world. We were there to maximize profit, unsurprisingly. We had no idea quite often how to maximize people other than putting them in cubicles, paying them in quintiles based on ranges of market comparables adjusted for performance reviews which could answer the questions asked but could not question the answers given. There were donuts; there were HR MEMOS on casual day policy violations. There were salaried people who would stay all weekend to help you out of the soup; there were people who would lie like a rug and throw their own grandmothers under the bus for an extra tick on some trade that was occurring for no other reason than to avoid corporate income taxes. There were days when it was so bland and boring and “professional” that one craved the odd sleazeball, in a perverse sort of way. I can remember doing business with Drexel. They were never boring.

So you could go home, some days, feeling the need for a spiritual as well as physical shower. Why would I—or anyone else with a conscience beyond vestigial levels required to support basic sapient functionality in prior evolutionary periods—have anything to do with this?

I put first-time homebuyers in starter homes.

I filled out 9-2900s and looked at DD-214s. Reviewed VC sheets. Priced quarter-coupons for Ginnie IIs. Tracked MICs. Learned the math for UFMIP-netting. You civilians don’t need to know what all this means—it’s as tedious and mind-numbing as it sounds. It’s the administrative and bureaucratic and desperately important risk-management part of doing FHA and VA loans to put first-time homebuyers into starter homes. It’s the nuts and bolts of the American Dream.

I was there, I had the dream, I drank the Kool Aid, I drafted the Letters of Intent to Participate in Pissant County’s latest bond program. I trained loan officers to understand how ARMs work, because I believed that I could get them to want to inform their customers—because it is the right thing to do. I could make it fun to be on the side of the angels, and still make a fair profit for the depositors and the shareholders and the employees.

It was some fine Kool Aid. My cup runneth over with it. I surely believed that goodness and mercy would follow me all the days of my life, and all those young dreamers I enabled would dwell in the house forever.

Perhaps I sound a bit angry from time to time. Broken-hearted people can be that way.

That’s all I have to say today.

by Calculated Risk on 4/03/2007 01:47:00 AM

From the WSJ: Office Rents Increase As Demand Stays Cool

Demand for office space in the U.S. remained sluggish in the first quarter ...

And guess what? Even as demand slows, supply is projected to increase as

... developers will open 76 million square feet of new office space by the end of this year.

The current office space absorption rate is about 8 to 10 million square feet per quarter - and will probably slow as the economy slows. But even though demand is slowing, the supply is already in the pipeline, so vacancy rates will most likely rise. That is why I am concerned about the exposure of U.S. banks to commercial real estate.

by Calculated Risk on 4/02/2007 11:29:00 PM

In the typical business cycle, non-residential investment follows residential investment. In a previous post, I presented the typical lag times for the two components of non-residential investment: 1) equipment and software, and 2) non-residential structures.

Click on graph for larger image.

The highest correlation for equipment and software is a lag of 2 to 3 quarters, and for structures a lag of 4 to 5 quarters. There is a positive correlation for other periods also.

The YoY change in residential investment turned negative in Q2 2006 (quarterly residential investment turned negative in Q4 2005).

For equipment and software, investment declined in two of the last three quarters. With a lag of 3 quarters, the YoY change would turn negative in Q1 2007. Of course the lag might be longer, or YoY investment might not turn negative this time. But it would be reasonable to expect the YoY change to turn negative soon.

So the only real surprise, in the following BusinessWeek article, is that BusinessWeek is, well, surprised!

From BusinessWeek: The Real Economic Threat: Weak Capital Spending

What's the biggest threat to the economy? The housing slump, right? After all, therein lies the greatest potential to derail consumer spending. Well, think again. Amid all the headlines about builders' woes, sagging home prices, and shaky subprime mortgages, there's some trouble brewing in another sector, perhaps more crucial to the outlook: capital spending.

And also from BusinessWeek is an article about consumers turning to credit card debt to partially offset less mortgage equity withdrawal: Borrowing Like There's No Tomorrow

Consumers are piling up credit-card debt at the fastest pace in years, and the housing downturn may be the reason. ...

The timing of the acceleration in revolving credit suggests consumers are turning to their credit cards as a partial replacement for reduced mortgage equity withdrawal ...

Kudos to dryfly for predicting this in the comments over a year ago.

by Calculated Risk on 4/02/2007 01:54:00 PM

From the WSJ: Subprime Pullback May Crimp Consumer Spending

Will it ... get harder for these consumers to buy cars, shop at the mall and dine out?

... many American families, [especially] subprime borrowers ... have been able to use the combination of rising home prices and easy credit to live beyond their means in recent years as wages have stagnated. That spending has helped to fuel the U.S. economy's growth.

... might force consumers to rein in spending, particularly lower-income Americans, who have piled up debt at a faster clip than their wealthier counterparts in the past decade. That could be a headache for the retailers, restaurateurs and others who depend on their business.

The article suggests that it will be lower-income Americans who cut back on their consumption, and the impact on the economy will be minor. However I think that a majority of MEW (Mortgage Equity Withdrawal) in recent years has been by middle income Americans, and flat or falling housing prices will also impact those borrowers. And middle income Americans will likely cut back on consumption too, even if they have no problem making their house payments.

by Calculated Risk on 4/02/2007 11:16:00 AM

Bloomberg reports: New Century Files for Bankruptcy Following Subprime Defaults

by Calculated Risk on 4/02/2007 10:44:00 AM

This is a key issue. According to the UCLA Anderson Forecast, Orange County, California (where I live) will avoid the worst of the housing bust. The logic goes something like this: Since there are very few first time buyers in O.C., there are very few subprime loans. Therefore there will be fewer homes in foreclosure, and less pressure on housing prices.

I disagree somewhat with this view. The areas with a high percentage of both housing related employment and subprime loans will most likely get hit the hardest (like California's Inland Empire). However areas like Orange County will not escape the carnage. In O.C., a large percentage of buyers used affordability products (like option ARMs) to purchase or refinance their homes. Many of these buyers will also get in trouble as housing prices stagnate and fall - it will just take a little longer than with the subprime borrowers.

Also, housing is a series of small chain reactions.

Click on graph for larger image.

Not all chain reactions start with a first time buyer using a subprime loan, but the loss of a large number of subprime buyers will impact an entire chain.

And it doesn't matter if the subprime buyer is in Orange County. The loss of a subprime buyer in Riverside means a moveup buyer can't purchase a home somewhere in Orange County.

Here is the story ...

From the O.C. Register: O.C.'s housing market to be spared worst of subprime fallout

The troubles in the subprime mortgage industry could bring stagnation to California's housing market, but Orange County should be spared the worst fallout, according to a UCLA economist.

In a report to be released today, Ryan Ratcliff, an economist with the UCLA Anderson Forecast, points out that markets with a higher proportion of first-time buyers and new homes – such as the Inland Empire and Ventura County – are seeing a bigger surge in defaults, or borrowers who fall 90 or more days behind on their mortgage payments, than areas like Orange County.
...
Orange County is "not a first-time buyer market or a market with a lot of new building," Ratcliff said in an interview. For those reasons, the recent rise in defaults is of a lesser magnitude here.
...
"Since the subprime market was almost the only thing keeping sales volume buoyant in the last years of the boom, the drying up of subprime credit suggests that home sales in California will be stagnant for some time to come," he writes.

by Tanta on 4/02/2007 10:43:00 AM

CFC's Angelo Mozilo reminds us why letting lenders regulate themselves has worked out so well.

He said adjustable-rate mortgages and loans made without a downpayment have been used for more than a generation with proven results.

“It’s very important that we put liquidity back in the system,” Mozilo said while co-hosting "Squawk Box." “It’s important that that the Fed backs off on these guidelines and that people realize hybrids are very good loans.”

We're from the mortgage industry and we're here to help.

by Calculated Risk on 4/02/2007 12:17:00 AM

From the WSJ: New Century May Announce Bankruptcy Filing

New Century Financial Corp. is expected to make an announcement early Monday ... people familiar with the situation said.

The company is widely expected to seek relief from creditors through a bankruptcy filing.

by Tanta on 4/01/2007 09:01:00 AM

CR may have posted on this study by researchers at the OCC and Federal Reserve Bank of St. Louis early last year just after it was published; at the time I was distracted by my post-surgical morphine pump (and you think I’m a Luddite?) and quite honestly was paying no attention to such matters. It’s not just that I’m too lazy to check the archives. Some questions have arisen in the comments recently about the history of subprime lending, as well as the extent to which depository institutions are implicated in it. So this may be worth a read even if we’ve been there before.

It’s a good paper; it’s also worth thinking about how off the mark some of its predictions about the direction of the subprime market turned out to be, just a year or two later. The authors were using data sets up to about mid-2004 and were writing in 2005, at what now appears the top of the real estate market in a lot of places. Even the list of subprime originators is sorely out of date: note the statement that “Household Financial Services, one of the original finance companies, has remained independent and survived the period of rapid consolidation. In fact, in 2003 it was the fourth largest originator and number two servicer of loans in the subprime industry.” Of course HSBC, a depository, was busy negotiating the purchase of HFS at the moment that sentence was written.

So the discussion here of the recent history of subprime originating is a bit dated in spots. What disappoints me is that the authors do not address one of the key facts about the situation in the 90s that I happen to remember: how the prime-lender depositories got their feet wet in subprime to start with.

Remember that back in the early-to-mid 90s, FICOs and AUS were still in development or not widely used, and nearly every loan was originated as “full doc” or what was called “alt doc,” which simply meant that it used borrower-provided documents (pay stubs, bank statements) instead of the probably more accurate but more expensive and time-consuming employer-provided or bank-provided documents (the Verification of Employment and Verification of Deposit forms a lender mailed to the relevant third party and received back, in the mail, with original signatures and in-depth information). Credit history was analyzed by looking at a full credit report (the old “RMCR” or “long-form” credit report ordered specially for residential mortgage applicants). Appraisals were all submitted on paper, with ink signatures and original photographs. Processing and then underwriting loans was time-consuming, and the application fee charged to a borrower was generally only enough to cover the actual cost to the lender of obtaining the credit report and appraisal. So the effort made by the lender to order verifications and evaluate the loan was sunk cost if the loan request was denied.

Several contexts converged here: after the S&L fiasco, prime depository lenders were finding themselves under some more attentive than usual regulatory supervision on safety and soundness issues, which, combined with RE busts, tended to make the declination rate for loan applications go up. At the same time, Fair Lending laws were getting enforced, which tended to make lenders less casual about having a high declination rate that they couldn’t justify on strictly credit-related grounds. For a lot of banks, specifically, the mortgage lending department (as opposed to other sources of loan assets like commercial, consumer, etc.) was a cyclical overhead-sink when rates went up (as they did in 1994-1995) and the refi boom of the early 90s came to an end.

Therefore, the issue of how one might recover some of those costs expended on loan applications one had ended up denying converged with the by-now commonplace idea that the prime-denied borrower class is an “underserved borrower segment” to create a willingness to dabble in subprime. If you, like me, had ever been handed a coffee mug with “There is no problem; there is only opportunity” emblazoned on it in some corporate pep rally in those days, you are familiar with the approach.

But the prime depositories of those days weren’t necessarily interested in placing these loans in their own investment portfolios, and they weren’t eligible for sale to the GSEs, which were the major buyers of loans the depositories didn’t hold. So banks and thrifts started developing whole-loan servicing-released loan sale programs, where the “fallout” from the prime pipeline could be recaptured by making a subprime loan and then selling it outright to a subprime conduit. Everybody gets a loan; all costs are eventually recouped; opportunity thrives. The subprime conduits could securitize the stuff and lay off the risk. It was great.

Except. There’s always an except. One unforeseen difficulty was that it became possible for certain participants who had always lived in the prime world to compare the profit margins on good old Fannie Mae fixed rates (maybe 50 bps if you were good at it) to those subprime deals (easily 150-200 bps if you were fair-to-middlin’ fastidious). Increased subprime lending could even improve those prime margins: as more and more of your weakest loans fell out of the bottom tier of your GSE loans and into the top tier of your subprime loans, you got paid better by the GSEs in the form of improved guarantee fees (since your average credit quality was so much better) and by your subprime investors (since your average credit quality was so much better). There was, in short, a moral hazard in play: in the shift from non-price to price rationing, more borrowers got mortgages, but it wasn’t always clear that they got the cheapest mortgage they should have gotten.

Those of us who were there at the time that the story about how “subprime is a way of serving the poor” got written do, then, tend to be somewhat more skeptical of this claim than others. The fact that many participants did not start out with the intention of preying on borrowers doesn’t change the fact that predation became widespread, or that a form of lending that had once been reserved for people with a lot of equity became associated just a few years later almost exclusively with people who had no money at all.

We can certainly debate the extent to which price-rationed lending provides true benefit to the historically credit-constrained. I’m game. I just think that market participants with short institutional memories are a menace. To all of us.