by Tanta on 11/13/2007 11:55:00 AM

From Triad's 10-K (thanks, Clyde):

On November 5, 2007, American Home Mortgage Investment Corp. and American Home Mortgage Servicing, Inc. filed a complaint against Triad Guaranty Insurance Corp. in the U.S. Bankruptcy Court for the District of Delaware. The plaintiffs are debtors and debtors in possession in Chapter 11 cases pending in the U.S. Bankruptcy Court. The lawsuit is an action for breach of contract and declaratory judgment. The basis for the complaint’s breach of contract action is the cancellation by us of our certification of American Home Mortgage’s coverage on 14 loans due to irregularities that we allegedly uncovered following the submission of claims for payment and that existed when American Home Mortgage originated the loans. The complaint alleges that our actions caused American Home Mortgage to suffer a combined net loss of not less than $1,132,105.51 and seeks monetary damages and a declaratory judgment. We expect to rescind additional loans originated by American Home Mortgage and we intend to contest the lawsuit vigorously.

Something to keep in mind: these days a lot of mortgage insurance works on the same "representation and warranty" business that everything else in mortgage-land does. The insurer does not necessarily or even usually underwrite the loan file itself prior to issuing a certificate; it "delegates" this to the lender. However, that means that the insurer can refuse to pay if it believes that the lender knew or should have known that the loan did not meet the insurer's requirements. The insurer generally doesn't find this out unless 1) the file is subject to routine QC audit or 2) the worst happens and a claim is filed.

So it's another episode of Finding Out Later, and the MIs don't want to hold the bag for it.

by Calculated Risk on 11/13/2007 11:35:00 AM

From John Spence at MarketWatch: Bank of America sees $3 bln in CDO mark-downs

Bank of America ... said it's currently estimating a $3 billion pretax charge in the fourth quarter to mark down collateralized debt obligations, or CDOs.
...
"As market conditions change and possibly worsen there could be additional diminution in value," [Chief Financial Officer Joe Price] warned.

by Calculated Risk on 11/13/2007 10:11:00 AM

The WSJ has an article today, Home Builders Opt for Mothballing, that starts with Lennar's decision to halt work on projects in Orange County, CA.

The WSJ article discusses an important point that we've discussed before. Many of the home builders are stuck with too much land and too much debt. They can't sell the raw land, so they keep building - and selling at a discount - to service their debt.

One alternative would be for builders to sell their land instead, but that market is even more dismal than the one for housing. Recent land transactions in California, Phoenix and Southeast Florida, while few in number, have fetched discounts of 70% and 80% on finished lots, according to Zelman & Associates, an independent housing research firm.
...
Some builders don't have the luxury of waiting for a brighter day. The more highly leveraged companies are slashing prices to move inventory to generate cash and pay down debt. This fall, builder Hovnanian Enterprises Inc., based in Red Bank, N.J., offered discounts on homes of as much as 30%, while Standard Pacific Corp., of Irvine, Calif., has been offering discounts and other incentives of as much as 25% on certain homes.
...
"Many builders are stuck between a rock and hard place," says Jonathan Dienhart, director of published research at Hanley Wood Market Intelligence, a housing research firm in Costa Mesa, Calif. "They can't make money by building, and they can't make money by not building. They have to choose the lesser of two evils."

To build or not to build: that is the question.

I suspect there is no right answer for some.

by Tanta on 11/13/2007 08:43:00 AM

Countrywide's October operations numbers are out. You can see the score here.

The financial press will report on the headline numbers (loan production down year over year, no kidding!). I confess that this little thing down in "Loan Closing Services" caught my eye: AVM (automated valuation of a mortgaged property) services for October: 5,793,171 units. For context purposes, CFC's entire $1.4 trillion servicing portfolio is 8,999,292 units. AVM volume for October 2006 was 539,126 units, and was only 6,743,360 units for the first three quarters of 2006. This is reported under "loan closing services," but quite obviously not all these AVMs are being run for newly closed or closing loans.

So, is CFC running AVMs on everything it owns and showing those as "production" of its loan closing services division? Or, is CFC selling AVM services to some other big portfolio?

Why should anyone care? I don't know . . . there's been some stuff in the news lately about lawsuits and inflated appraisals . . . I'd sure love to know whether somebody is busy getting a AVM on every loan it's exposed to . . .

by Calculated Risk on 11/12/2007 05:20:00 PM

From Dow Jones (no link yet): Fitch Downgrades $37.2B Of CDOs, Slashing AAAs to Junk

Fitch Ratings downgraded Monday the credit ratings of $37.2 billion of global collateralized debt obligations, with more than $14 billion worth of transactions falling from the highest-rated AAA perch to speculative-grade, or junk, status.
...
The rating agency said more than 60 CDO transactions are still on watch for potential downgrade, with a resolution due on or before Nov. 21.

On Monday, nearly $20 billion worth of transactions was cut from investment-grade to junk, said Kevin Kendra, managing director at Derivative Fitch.

From AAA to Junk in one fell swoop!

by Calculated Risk on 11/12/2007 04:53:00 PM

In his most recent post, Professor Roubini commented on the impact of less homeowner equity extraction on consumption.

Note that Roubini calls equity extraction HEW (Home Equity Withdrawal) and I usually refer to it as MEW (Mortgage Equity Withdrawal). MEW has been used for years, but HEW is a more accurate description.

Roubini writes:

... there is the effect of home equity withdrawal (HEW) on consumption. There is some debate in the literature on whether the effect of HEW is a proxy for the wealth effect or an additional and separate effect. Again the literature has a variety of estimates ranging from 50% of HEW being consumed according to Greenspan-Kennedy to 25% of it being consumed according to other studies. The appropriate measure of HEW is also important: gross or net, overall or active. HEW peaked at $700 billion annualized in 2005 and has dropped to about $150 billion by Q2 of 2007. So, the fall in consumption – assuming unrealistically no further fall in HEW from now on – would be $275 billion based on the Greenspan-Kennedy estimates or about $140 billion according to the more conservative estimates. Evidence suggests that this effect of HEW on consumption occurs with lags; that is why we have not yet seen its full effects on consumption as late as Q3. Rather, we will see its effects in the next few quarters. Another interpretation – according to Zandi – is that HEW (measured in a different way) has started to fall only in the recent quarters; so again the effect of falling HEW on consumption will be observed mostly in 2008.

First, for those that want to follow along, here is a copy of the Kennedy-Greenspan data for Q2 in Excel. NOTE this request from the Fed:

These data are the product of a research project undertaken by James Kennedy and Alan Greenspan. The data are not an official publication or product of the Federal Reserve Board. If you cite these data, please reference one of the two papers that Jim wrote with Alan Greenspan. For example, a reference might read something like this:

"Updated estimates provided by Jim Kennedy of the mortgage system presented in "Estimates of Home Mortgage Originations, Repayments, and Debt On One-to-Four-Family Residences," Alan Greenspan and James Kennedy, Federal Reserve Board FEDS working paper no. 2005-41."

Here are the Seasonally Adjusted Annual Rate (SAAR) Kennedy-Greenspan estimates of home equity extraction through Q2 2007, provided by James Kennedy based on the mortgage system presented in "Estimates of Home Mortgage Originations, Repayments, and Debt On One-to-Four-Family Residences," Alan Greenspan and James Kennedy, Federal Reserve Board FEDS working paper no. 2005-41.

For Q2 2007, Dr. Kennedy calculated Net Equity Extraction as $494.4 Billion (SAAR), or 4.9% of Disposable Personal Income (DPI).

This graph shows the MEW results, both in billions of dollars quarterly (not annual rate), and as a percent of personal disposable income.

Roubini is suggesting the MEW has declined significantly in Q2. I think this is incorrect. Roubini wrote:

HEW peaked at $700 billion annualized in 2005 and has dropped to about $150 billion by Q2 of 2007.

According to Dr. Kennedy, MEW was about $140 Billion in Q2 2007 (or a seasonally adjusted annual rate of almost $500 Billion). So MEW hasn't fallen very far yet! This actually makes Roubini's argument even stronger. So I'd argue the following sentence is also incorrect:

So, the fall in consumption – assuming unrealistically no further fall in HEW from now on – would be $275 billion based on the Greenspan-Kennedy estimates or about $140 billion according to the more conservative estimates.

In fact I expect MEW to fall signficantly starting in Q4 2007. As of Q2, 2007 the consumption impact of falling MEW (using 50%) would be closer to $25 Billion per quarter ($100 Billion annualized), and even though there appears to be a lag from equity extraction to consumption, most of the decline in equity extraction is still ahead of us.

In fact it appears MEW was strong in Q3 based on my advance estimate. Using the Q3 GDP data from the BEA, my advance estimate for Mortgage Equity Withdrawal (MEW) is approximately $520 Billion (SAAR) or 5.1% of Disposable Personal Income (DPI). This would be slightly higher than the Q2 estimates, from the Fed's Dr. Kennedy, of $494.4 Billion (SAAR), or 4.9% of Disposable Personal Income (DPI).

The actual Q3 data for MEW is released after the Flow of Funds report is available from the Fed (scheduled for December 6th for Q3).

Click on graph for larger image.

This graph compares my advance MEW estimate (as a percent of DPI) with the MEW estimate from Dr. James Kennedy at the Federal Reserve. The correlation is pretty high (0.90, R2 = 0.81) but there are differences quarter to quarter. This does suggest that MEW was at about the same level in Q3 as Q2. We will have to wait until September to know for sure.

MEW will probably decline precipitously in the Q4 2007, with a combination of tighter lending standards and falling house prices. The impact of less equity extraction on consumer spending is still being debated, but I agree with Roubini that a slowdown in consumption expenditures is likely.

by Calculated Risk on 11/12/2007 02:37:00 PM

From John Hussman (hat tip Duceswild): Expecting a recession

In recent months, I've repeatedly noted that while recession risks were gradually increasing, there was not sufficient evidence to expect an imminent economic downturn. Most economists still believe this. On Saturday, the consensus of economists surveyed by Blue Chip Economic Indicators indicated expectations that growth will be sluggish into next year, but that there will be no recession. Unfortunately, the economic consensus has never accurately anticipated a recession. For my part, the outlook has changed. I expect that a U.S. economic recession is immediately ahead.

From Nouriel Roubini: The Coming US Consumption Slowdown that Will Trigger an Economy-Wide Hard Landing

Any recession call for the U.S. is clearly dependent on US consumption faltering. Since residential investment is only 5% of even a worsening housing recession cannot – by itself – trigger an economy-wide recession. Rather, since private consumption is over 70% of aggregate demand a sharp and persistent slowdown in consumption growth – below 1% or even negative - is necessary to trigger a full blown recession.

In this regard, evidence is mounting that a debt-burdened and saving-less US consumer – that until recently used its home as an ATM and borrowed against its housing wealth - is now on the ropes and at its tipping point.

... a sharp slowdown in consumption growth will be the last straw that will trigger an economy wide recession. Expect Q4 growth to be 1% or below and this growth further to accelerate into negative territory by H1 of 2008.

And Roubini on the housing wealth effect:

... there is the wealth effect of falling home values. Estimates of such a wealth effect range in between 5% and 7% of the change in wealth ... The total wealth effect of housing on consumption also depends on how much home values will fall. Current estimates range between a consensus of at least 10% price fall, some suggesting a 15% fall and some – like myself and others – arguing that home prices will fall 20% or more. According to Fed data, the market value of the US residential housing stock was $21.0 trillion at the end of the second quarter of 2007. Thus, the fall in housing wealth could be in the $2 trillion (for a 10% drop in home prices) to $4 trillion range (for a 20% drop in prices). At $2 trillion and with a 5% effect one gets a fall in real consumption of $100 billion; with $4 trillion and with a 7% effect you get a fall in consumption of $280 billion.

I'll get back to Roubini's discussion of the impact of home equity withdrawal on consumer spending.

Note that Roubini has been pretty bearish for some time, but I believe this is a new position for John Hussman.

by Calculated Risk on 11/12/2007 12:10:00 PM

According to the BLS, residential construction employment has only declined 6.5% from the peak employment in 2006 (221,900 fewer jobs). This is surprising because housing completions are off about 37% from the peak.

Click on graph for larger image.

This graph shows starts, completions and residential construction employment. (starts are shifted 6 months into the future). Completions and residential construction employment were highly correlated, and Completions typically lag Starts by about 6 months.

The puzzle is why residential construction employment hasn't fallen further.

The following article from the Beaufort Gazette provides some clues: Housing meltdown hammers construction industry

Beekman Webb put a classified advertisement in the newspaper a couple of weeks ago for a carpenter's assistant and "had about 50 calls in three days."

"I was just covered up, and I was the only ad in the paper at the time looking for carpentry help," said Webb, who has his own Beaufort-based construction company.

"I had people from Hilton Head (Island) that told me they'd been in business for 15 years with a bunch of employees and now they're just looking for a job as a carpenter," he said.

The housing market slump has had a trickle-down effect on the area's residential construction industry, according to local builders. Gerald Neal, owner of Neal's Construction in Beaufort, first noticed the slowdown earlier this year.

"It's real tough times for those guys -- the (residential construction) subcontractors. They're having a rough time," he said.

The local commercial construction industry has not been hit quite as hard, according to Neal, which has made him change the way he operates his business.

"I used to do 20 percent commercial. Today, I do about 60 percent commercial, 40 (percent) residential," Neal said.

This hits on two of the explanations for the residential construction employment puzzle: many workers have moved to commercial work (note that Neal has moved from 20% percent commercial to 60% commercial), and many workers are underemployed.

Other possible reasons for the employment puzzle are that the BLS has not correctly accounted for illegal immigrants working in the construction industry, and the BLS Birth/Death model might have missed the turning point in residential construction employment.

There is some merit to to all of these arguments, and I think the answer will be some combination of these explanations. The concern now is that if commercial construction spending slows, as appears likely from the recent Fed loan survey, then workers that have moved to commercial construction will have no work opportunities.

This was the concern expressed by the director of forecasting of the NAHB in August. From Reuters: Construction job losses could top 1 million

"The ability of nonresidential to continue absorbing additional workers is going to be limited, and that's going to put downward pressure on construction employment overall," [Bernard Markstein, director of forecasting at the National Association of Home Builders] said, adding that cuts may be deeper than in the 1990s.

by Calculated Risk on 11/12/2007 09:38:00 AM

Back in July, Bernanke suggested the subprime related losses would be in the $50 Billion to $100 Billion range:

"Some estimates are in the order of between $50 billion and $100 billion of losses associated with subprime credit problems," [Bernanke] said (July 19, 2007).

Last week, the Royal Bank of Scotland pegged the total losses at $250 Billion to $500 Billion:

``This credit crisis, when all is out, will see $250 billion to $500 billion of losses,'' London-based Janjuah said.

Now from Bloomberg: Subprime Losses May Reach $400 Billion, Analysts Say

Losses from the falling value of subprime mortgage assets may reach $300 billion to $400 billion worldwide, Deutsche Bank AG analysts said.

Wall Street's largest banks and brokers will be forced to write down as much as $130 billion because of the slump in subprime-related debt, according to a report today by Mike Mayo, a New York-based analyst. The rest of the losses will come from smaller banks and investors in mortgage-related securities.

As I've noted before, Mayo has really been on top of the Wall Street losses.

Also these losses don't include the coming $2+ Trillion in household net worth losses due to house prices falling over the next couple of years.

by Calculated Risk on 11/12/2007 09:30:00 AM

From MarketWatch: Citi downgrades E-Trade to sell rating (title hat tip Herb Greenberg)

"We estimate that trying to liquidate E-Trade's loan and ABS portfolio would result in over $5 billion of losses, more than wiping out tangible equity," Citi analysts said.
...
"Bankruptcy risk cannot be ruled out," they said.

A "sell" rating and the B-word. Watch out for the death threats.