by Tanta on 7/30/2007 08:29:00 AM

This lede is from the bleedin' Economist, no less:

A hedge fund stalks subprime's next potential victim

If you got the part about how the bond insurer is the "victim" of "subprime" but is being "stalked" by a hedge fund, you probably got that part of The Queen where it turns out that Diana was a buck.

I'm surprised and stunned.

by Tanta on 7/30/2007 08:07:00 AM

From Financial Times:

Investment banks are responding to rising credit concerns by imposing tougher lending terms on hedge funds, in a move that threatens to exacerbate investor unease in the financial markets.

Prime brokerage departments at several investment banks have raised their margin requirements for certain hedge fund clients as they seek to insure themselves against the possibility of new hedge fund collapses as a result of the recent market turmoil.

“Financing terms for hedge funds are being tightened and this is forcing a further deleveraging of risk across global markets,” said Gerald Lucas, senior investment adviser at Deutsche Bank.

One prime broker said his bank had started examining its lending criteria in the wake of the much publicised problems at two hedge funds run by Bear Stearns.

“Recently we have broadened our stricter standards to funds beyond those with exposure to US mortgage market. I’d say this is now a pretty broad-based retreat from leverage.”

Now, if they just get rid of that "stated returns" product. . . .

by Calculated Risk on 7/29/2007 07:03:00 PM

From the Financial Times: US subprime crisis shows signs of spreading

AHM said it is delaying paying dividends ...

The move represents one of the first indications that the crisis facing sub-prime mortgage lenders in the US is expanding to affect lenders like American Home Mortgage whose borrowers tend to have higher 'prime' ore 'near prime' credit ratings.

"First indications"? Are they joking?

by Calculated Risk on 7/29/2007 05:35:00 PM

This is an update to my 2007 housing forecast.

Probably the most important housing numbers are sales (new and existing homes), prices, and housing starts.

Starting with Existing Homes, my original forecast was for sales of 5.6 to 5.8 million units in 2007. To date, through June, the NAR has reported sales of 2.929 million units.

Lending standards are being tightened again, and this will most likely impact sales in the 2nd half of 2007. Since existing home sales are reported at the close of escrow, many of the July and August sales were in process before the most recent round of tightening - so I've assumed only a minor impact on reported sales for July and August (as compared to 2005 and 2006). I've assumed a greater impact on sales for the last four months of the year.

Click on graph for larger image.

This graph shows my current month by month forecast for existing home sales this year (red is actual for 2007). It is possible that sales will fall off a cliff later this year, but that kind of decline is extremely difficult to predict, and I think a more gradual decline is likely.

My current forecast is for 5.6 million units; at the bottom end of my original forecast range.

For anyone interested, you can enter our contest: Forecast 2007 Existing Home Sales. PLEASE enter your forecast in the comments to the contest thread (not in the comments here) so I know where to look in January. Thank you!

For New Home sales, my original forecast was that sales would "surprise to the downside" compared to Fannie Mae's forecast of 975 thousand units. Through June, the Census Bureau has reported sales of 458 thousand units.

Sales are reported for New Homes when the contract is signed, so the recent tightening of lending standards will probably impact reported New Home activity sooner than reported existing home activity. My current forecast for New Home sales is for a total of 830 to 850 thousand units.

For existing home prices, my forecast was for prices to decline "nominally by 1% to 3% nationwide by all measures (OFHEO, NAR)." So far prices are up slightly according to the NAR:

The national median existing-home price for all housing types was $230,100 in June, up 0.3 percent from June 2006 when the median was $229,300.

Down slightly according to the FHFB.

The FHFB reported the decline in the average price was $501, or 0.16 percent, from $306,759 in October 2005 to $306,258 in October 2006. This is the first decline in the MIRS since 1992-93.

And up in the first quarter according to the OFHEO (the second quarter OFHEO House Price Index is scheduled to be released on August 30).

The OFHEO House Price Index (HPI), which is based on data from sales and refinance transactions, was 0.5 percent higher in the first quarter than in the fourth quarter of 2006.

All of these methods have flaws and are based on nationwide price changes. I'll stick with my forecast of a 1% to 3% price decline nationwide in 2007.

Housing Starts. In my 2007 housing forecast, I didn't forecast starts. However, last year I calculated that completions might fall to 1.2 million units per year, and starts might fall even further to 1.1 million units per year. It now appears starts will be in the 1.4+ million range for 2007. What I overlooked was that the builders would get caught in a self destructive Nash equilibrium: the homebuilders have to keep building, because they can't sell the land. And they builders can't gain by changing their own behavior, because the industry is very fragmented and the other builders will keep on building. In the aggregate, this behavior is self destructive, but it makes sense for each individual builder.

I still think starts will decline significantly from the current level to work off the record levels of inventory. And it's the total inventory (new and existing homes) that matters: as an example, see this story from the WaPo yesterday: Glut of Condos Pits Private Sellers Against Developers.

I'll have more on starts, inventory levels, and the excess housing stock in the near future.

by Tanta on 7/28/2007 10:10:00 AM

American Home Mortgage Edition.

by Tanta on 7/28/2007 09:12:00 AM

Mr. Ubiquitous, Joshua Rosner, got some op-ed space in the New York Times the other day. (Perhaps he's gotten a bit impatient with merely being Gretchen Morgenson's go-to guy on this topic and wants the byline.) So open up the paper with me, and read:

FOR five months, it has been clear that

Ack! Ack! Ack! (Sorry, friends, but that coffee that just came out of my nose was hot).

rising delinquencies and foreclosures, coupled with higher interest rates on adjustable mortgages and declining home price appreciation, would undermine the market for mortgage securities. Yet it took Moody’s Investors Service, Fitch Ratings and Standard & Poor’s, the three leading agencies that rate long-term debt, until this month to react to this looming financial crisis, which involves more than $1.2 trillion of subprime mortgages originated in 2005 and 2006 alone. As one investor asked during a recent S.&P. conference call, “What is it that you know today that the markets didn’t know three months ago?”

The S&P analyst in my dreams replied: "Well, Bob, we knew you knew this three months ago but you bloody weren't going to sell any of it until we downgraded it, so we had a pool going in the office to see how long we could play chicken with you. Sorry you're so upset, but I won $100 off you just this morning, so this wasn't an entire waste of time. If Mr. Market is so damned much smarter than we are, why weren't you happily playing ratings arbitrage? Don't tell me you're still long? Ha ha ha ha ha--excuse me. Next question?"

The two largest credit rating agencies, Moody’s and S.&P., announced two weeks ago that they are reviewing and lowering ratings on many of the $17.2 billion in residential mortgage-backed securities. They are doing the same for the pools of these loans known as collateralized debt obligations. The effort is, to use a well-worn but apt phrase, too little, too late. But it is not too late for regulators and legislators to take steps to restore investor confidence and to ensure the future of these markets.

I assume all readers of this blog understand what "restoring investor confidence" means. If you don't, would you like to buy some cheap mortgage-backed securities?

The subprime crisis has not been averted. In fact, it is still largely ahead of us. The downgrades represent only a small fraction — about 2 percent of the mortgage-backed securities rated for the year between the fourth quarters of 2005 and 2006 — of what the rating agencies suggest could be a mountain of bad debt held by investors, including pension plans, banks and insurance companies. The agencies are primarily downgrading assets with expected losses that are already working their way through the pipeline. They are not projecting future losses.

Of course they're projecting future losses. That's why so many of them went on that "Watch Negative" thingie. Tanta begins to think there might be something tendentious going on here.

Nor do the downgrades apply only to lower-rated securities. Some even relate to the performance of debts that are rated AAA, meaning the agencies judged them to be of the best quality — bulletproof.

The credit ratings agencies play a more important role in debt markets than stock analysts do with regard to equities. No one was told they could buy a certain stock only if, for example, an unscrupulous stock analyst said it was a “buy.” But regulators require banks, insurance companies and pension managers to purchase only high-quality debts — and the quality is judged by ratings agencies.

"Bulletproof"? The regulatory distinction is between "speculative grade" and "risk free"? Those banks and others are holding reserves and risk-based capital against their "investment grade" assets because S&P promised that the money was both "invested" and "sewn into the mattress" at the same time? I must have been watching Star Trek reruns when that news got posted on Yahoo! Finance.

Fitch, Moody’s and S.&P. actively advise issuers of these securities on how to achieve their desired ratings. They appear to be helping investment banks, hedge funds and fund companies, all of which have a fiduciary obligation to investors, to develop the worst possible product that would still achieve a certain rating.

Really? Tell it to the people who got an IO 2/28 with a 6.50% margin and a prepayment penalty, brother. There's a big, competitive contest for "worst possible product."

S.&P. has stated that it now has reason to “call into question the accuracy of some of the initial data provided to us.” This suggests that S.&P. may have chosen either to merely accept the data offered it by issuers without doing its own due diligence. Or worse, S.&P. could have ignored other information because it might have hurt revenues by reducing the number of assets it could have rated.

Those data tapes had doc type codes on them, dude, which did appear in your prospectus. Which part of "stated income" has you confused? What exact kind of "due diligence" did you think was going to help with that problem? ("Let's see . . . originator claims the borrower's income is unverified and unverifiable. Hmmm . . . well, that looks right to me. Next file!")

The Securities and Exchange Commission, working with Congress if necessary, should require the credit rating agencies to regularly review and re-rate debt securities. Rating agencies are typically paid by issuers and only for initial ratings, which leads to much of the shoddy analysis and questionable timing in the re-rating of securities.

Training and qualification standards for ratings analysts should also be required to help create consistent, objective, transparent and replicable methods. Moreover, rating agencies should put in place automated and objective systems, based on the changing value of underlying assets, to continuously re-rate debt structures.

Lastly, many accountants and government officials endure a “cooling off” period before they can work for a client. A similar delay for ratings analysts would greatly enhance the integrity and independence of the rating process. Right now, nothing stops a ratings analyst from taking a lucrative job at a bank whose deal he has just rated.

Each of these actions would serve the interest of investors large and small, public and private. Unless the government acts, the credit ratings agencies will stand on the sidelines of the coming crisis, doing nothing until it’s already happened.

Don't get me wrong. I'm all in favor of investors having to shell out money for due diligence. I have this idea that increasing the up-front cost of risk-taking (rather than leaving it all "back-loaded") might introduce a tad bit of market discipline. I could also work up some enthusiasm for stock analysts who stop punishing mortgage originators for having too much of that "operational expense" like Quality Control analysts who haven't been laid off yet. And simply licensing mortgage brokers and forcing them to have basic fiduciary requirements would warm the cockles of my disgusted little heart.

It is possible that after all that, I could get talked into shedding a few precious, glistening tears for hedge fund investors who do not themselves wish to be regulated, but who wish the rating agencies to be regulated, so that they can chase yield with no risk. But, you know, before I get behind any regulatory policy that "protects" these guys from the for-profit rating agencies onto which they happily off-load the unglamorous parts of being a Big Money Investor, I want to know what they're holding, and how those hedges are doin'. Open kimono for me, open kimono for you.

Ed. Note: I wrote this the other day* but forgot to publish it. As Mad-Eye Moody** would say, "Constant vigilance!"

*Hat tip, AS!

**No relation to the rating agency

by Calculated Risk on 7/28/2007 02:31:00 AM

From the WSJ: Hints of Broader Problems Arise in Real-Estate Loans

Delinquencies on loans that back commercial mortgage-backed securities rose for the first time since 2003 in the second quarter, potentially a sign that real-estate problems are broadening to the commercial sector.

CMBS delinquencies rose 13% in the second quarter to $1.65 billion from $1.46 billion in the first quarter, according to a new report by Standard & Poor's, which attributes the rise to overaggressive loans made in 2006, as well as increased problems in the retail sector.

The AHM story will get the buzz (previous post), but this actually might be more important for the overall economy.

by Calculated Risk on 7/28/2007 02:06:00 AM

Press Release: American Home Mortgage Investment Corp. Delays Payment Dividends (hat tip barely)

American Home Mortgage Investment Corp. announced today that its Board of Directors has decided to delay payment of its quarterly cash dividend ... in order to preserve liquidity until it obtains a better understanding of the impact that current market conditions in the mortgage industry and the broader credit market will have on the Company's balance sheet and overall liquidity. The disruption in the credit markets in the past few weeks has been unprecedented in the Company's experience and has caused major write-downs of its loan and security portfolios and consequently has caused significant margin calls with respect to its credit facilities.

The quarterly cash dividend of $0.70 per share on the Company's common stock had been declared on June 15, 2007 and was to be paid on July 27, 2007 to all shareholders of record as of July 9, 2007. The Series A Preferred Stock dividend and Series B Preferred Stock dividend had been declared on June 15, 2007 and are payable on July 31, 2007, to shareholders of record as of July 9, 2007.
emphasis added

I can't recall a declared dividend being "delayed". This can't be good.

by Calculated Risk on 7/27/2007 10:20:00 PM

From the Census Bureau on Residential Vacancies and Homeownership

National vacancy rates in the second quarter 2007 were 9.5 (+/- 0.4) percent for rental housing and 2.6 (+/- 0.1) percent for homeowner housing, the Department of Commerce’s Census Bureau announced today. The Census Bureau said the rental vacancy rate was not statistically different from the second quarter rate last year (9.6 percent), but was lower than the rate last quarter (10.1 percent). For homeowner vacancies, the current rate was higher than a year ago (2.2 percent), and lower than the rate last quarter (2.8 percent). The homeownership rate at 68.2 (+ 0.5) percent for the current quarter was lower than the second quarter 2006 rate (68.7 percent), but was not statistically different from the rate last quarter (68.4 percent).

Click on graph for larger image.

The first graph shows the homeowner vacancy rate since 1956. A normal rate for recent years appears to be about 1.7%. There is some noise in the series, quarter to quarter, but it does appear the decline in Q2 was statistically significant.

This small decline in Q2 leaves the homeowner vacancy rate almost 1% above normal, or about 750 thousand excess homes.

The rental vacancy rate has been trending down for almost 3 years (with some noise). This was due to a decline in the total number of rental units in 2004, and more recently due to more households choosing renting over owning.

It's hard to define a "normal" rental vacancy rate based on the historical series, but we can probably expect the rate to trend back towards 8%. This would suggest there are about 600 thousand excess rental units in the U.S. that need to be absorbed.

More on this when I finish my mid-year housing update.

by Calculated Risk on 7/27/2007 06:46:00 PM

Note: This is an estimate of the total increase in household mortgage debt, not to be confused with MEW (Mortgage Equity Withdrawal or extraction). MEW is a subset of this amount. The gold standard for net equity extraction is the Kennedy-Greenspan data usually available, courtesy of Dr. Kennedy, a few days after the Fed's Flow of Funds report is released. For Q2 2007, the Flow of Funds report is scheduled to be released on September 17, 2007.

As a supplement to the advance GDP report (released today), the BEA provides an estimate of mortgage interest paid for the quarter, and the effective mortgage interest rate. With a little work, an estimate of the total increase in mortgage debt for the quarter can be derived.

Click on graph for larger image.

This graph shows the quarterly increase in household mortgage debt based on the Fed's Flow of Funds report compared to the BEA derived increase in mortgage debt. Note that the BEA data is Seasonally Adjusted (SA) and the Flow of Funds data is Not Seasonally Adjusted (NSA).

NOTE: It is difficult to compare NSA vs. SA data. In this case, the current quarter (Q2) appears to have the least seasonal adjustment. Use with caution: my confidence in this analysis for any single quarter is not high.

The BEA data suggests that total household mortgage debt increased by $188 Billion in Q2. If this estimate is close, this suggests that MEW increased in Q2 - possibly boosting consumer spending. If this advance estimate is correct, this will be a surprise - an understatement - and raise even more concerns about consumer spending later this year.