by Calculated Risk on 11/27/2007 01:35:00 PM

Peter Y. Hong at the LA Times writes: Homeowners' big question: How low will prices go?

Click on graph for larger image.

The LA Times article focuses on California. This graph shows the Case-Shiller home price index for several selected cities. If SoCal prices fall 25%, then prices in other areas - like Miami and Las Vegas - will probably decline a similar amount. These are nominal prices, I'll have more on Real vs. Nominal prices later today.

From the LA Times:

No one knows how severe the slump will be, but economists and real estate experts interviewed by The Times, and who were willing to make predictions, said prices could fall 15% to 25% before turning back up.

Most said values would continue falling through at least next year, and some thought the market wouldn't reverse course until 2010.

That could translate to big declines for home buyers who bought at the peak of the market, which various measures place in late 2006 or early 2007.
...
Some analysts, including UC Berkeley professor Kenneth Rosen, believe the severity of the downturn will vary by region.

Areas such as the Central Valley and the Inland Empire will be the hardest hit, he said, because these attracted a higher percentage of new buyers with shaky credit, and many of them are now defaulting on their loans. He believes values in these communities could fall by 15%.

But "in areas where there is very little new housing, where it's hard to build and a lot of wealthy people live, there will be little decline or maybe none at all."
...
But others call this wishful thinking, saying low prices eventually work their way to even the most affluent areas.

"Every place takes the hit in the long run," said Christopher Thornberg of Beacon Economics, a consulting firm in L.A.
...
[Edward E. Leamer of UCLA's Anderson Forecast] and Thornberg are among the most bearish of analysts, saying the recently ended housing boom pushed prices out of sync with incomes.

Los Angeles County median home prices are about 40% to 50% higher than the median income justifies, Thornberg said. He said the market would settle when prices and incomes became more closely aligned.

"Southern California prices will fall 25% from their peak and won't find their bottom until the end of 2009," Thornberg said.

Leamer also sees a drop-off at the high end of the range -- 20% to 25% -- and sees the downturn lasting into 2010.

by Calculated Risk on 11/27/2007 11:08:00 AM

From OFHEO: 2008 Conforming Loan Limit $417,000

Office of Federal Housing Enterprise Oversight Director James B. Lockhart today announced the maximum 2008 conforming loan limit for single-family mortgages purchased by Fannie Mae and Freddie Mac (the Enterprises) will remain at the 2007 level of $417,000 for one-unit properties for most of the U.S. Higher limits apply to Alaska, Hawaii, Guam and the U.S. Virgin Islands as well as to properties with more than one unit.

The conforming loan limit determines the maximum size of a mortgage that an Enterprise can buy or guarantee. By law the maximum conforming loan limit is based on the October-to-October change in the average house price in the Monthly Interest Rate Survey (MIRS) of the Federal Housing Finance Board (FHFB). The FHFB reported the decline in the average price was $10,685 or 3.49 percent, from $306,258 in October 2006 to $295,573 in October 2007. The combined two-year decline is now 3.65 percent.

“While the house price survey data used in determining the conforming loan limit show a decline over the past year, as previously announced and consistent with the proposed new conforming loan limit guidance, the level will remain at $417,000 for the third straight year,” said Lockhart.

The FHFB is reporting the year over year national price decline was 3.49%.

by Calculated Risk on 11/27/2007 09:58:00 AM

From MarketWatch: Home prices falling everywhere: S&P

U.S. home prices were falling in every region of the country in September, according to a closely watched index of home prices released Tuesday.

Home prices fell in September in all 20 major cities covered by the Case-Shiller price index, even in cities that had been holding up before the August freeze in mortgage markets, Standard & Poor's reported.

"There is no real positive news in today's data," said Robert Shiller, chief economist at MacroMarkets LLC, and the co-developer of the index.

For the national Case-Shiller home price index, prices fell 1.7% in the third quarter compared with the second quarter, and were down a record 4.5% in the past year. It was the largest quarter-to-quarter price decline in the 20 years covered by the index.

by Calculated Risk on 11/27/2007 12:35:00 AM

From the WSJ: Abu Dhabi to Bolster Citigroup With $7.5 Billion Capital Infusion

Citigroup Inc. ... is receiving a $7.5 billion capital infusion from the investment arm of the Abu Dhabi government.
...
As a result of the deal, the investment authority known as ADIA will become one of Citigroup's largest shareholders, with a stake of no more than 4.9%.
...
In exchange for its investment, ADIA will receive convertible stock in Citigroup yielding 11% annually. The shares are required to be converted into common stock at a conversion price of between $31.83 and $37.24 a share over a period of time between March 2010 and September 2011.

by Calculated Risk on 11/26/2007 08:52:00 PM

From the Cleveland Fed: Fed Funds Rate Predictions

Click on graph for larger image.

A number of Fed presidents will be speaking this week, including Cramer's favorite Fed President William Poole on Friday.

The Fed has been saying don't expect a rate cut in December; meanwhile the market is debating the size of the cut: 25bps or 50bps.

Since the credit crunch is worsening again, I've linked to Cramer's August meltdown at the bottom of the posts.

by Calculated Risk on 11/26/2007 04:07:00 PM

The Irvine Housing blog brings us these details (hat tip Atrios):

Asking Price: $1,249,000 Purchase Price: $1,157,000 Purchase Date: 1/6/2005

According to the Irvine Housing blog:

The property was purchased in January 2005 for $1,157,000. The combined first and second mortgages totalled $1,156,730 leaving a downpayment of $270. Let’s just call it 100% financing.

By April, they owners were able to find refinancing through Countrywide with a $999,999 first mortgage. This mortgage was an Option ARM with a 1% teaser rate. The minimum payment would be $3,216 per month.

Also in April of 2005, they took out a simultaneous second mortgage for $215,000 pulling out their first $58,000.

So look at their situation: They are living in a million dollar plus home in Turtle Ridge making payments less than those renting, and they “made” $58,000 in their first 4 months of ownership.

Apparently, these owners liked how hard their house was working for them, so they opened a revolving line of credit (HELOC) in August 2005 for $293,000. Did they spend it all? I can’t be sure, but the following certainly suggests they did.

In December of 2005, they extended their HELOC to $397,990.

In June of 2006, they extended their HELOC to $485,000.

In April of 2007, the well ran dry as they did their final HELOC of $491,000. I bet they were pissed when they couldn’t get more money.

So by April 2007, they have a first mortgage (Option ARM with a 1% teaser rate) for $999,999, and a HELOC for $491,000. These owners pulled $333,000 in HELOC money to fuel consumer spending.

Assuming they spent the entire HELOC (does anyone think they didn’t?), and assuming the negative amortization on the first mortgage has increased the loan balance, the total debt on the property exceeds $1,500,000. The asking price of $1,249,000 does not look like a rollback, but if the property actually sells at this price, the lender on the HELOC (Washington Mutual) will lose over $300,000.

These owners will probably just walk away. I doubt they have any assets. They never put any money into the deal, they pulled out $333,000 in cash, and they got to live in Turtle Ridge for 3 years. Not a bad deal — for them.

This story has been repeated all across America (usually on a smaller scale). This was not a subprime loan when the home was first purchased, but the collateral is now less than the total loan amount. The house hasn't sold yet, so perhaps the $999,999 Option ARM first is also impaired.

And look at the Mortgage Equity Withdrawal (MEW). One third of a million dollars, or over $100K per year. Perhaps the money was invested. Perhaps it was spent on new cars, flat screen TVs, vacations, or more - but this Home ATM appears out of money, and I suspect that will impact the homeowners' lifestyle.

This illustrates two important points: We are all subprime now, and, with falling house prices, the Home ATM is running dry.

by Calculated Risk on 11/26/2007 02:02:00 PM

From MarketWatch: Citigroup leads slide on report of 'massive' layoffs

Citigroup shares fell Monday after CNBC reported the firm could lay off up to 45,000 staffers ...

CNBC reported early Monday that the bank is planning a large number of layoffs as part of a response to recent huge write-offs for bad mortgage investments.

CNBC described the layoffs as "massive" and said they would not be restricted to the fixed income and mortgage divisions.

In April, Citi set layoffs of 17,000 people, or about 5% of its more than 300,000 employees.

UPDATE: a comment from Citi via the WSJ :

"We are engaged in a planning process in anticipation of our new CEO, and our business heads are planning ways in which we can be more efficient and cost effective to position our businesses in line with economic realities," [Citi] spokeswoman Christina Pretto said in a statement ... "any reports on specific numbers (of layoffs) are not factual."

by Calculated Risk on 11/26/2007 12:10:00 PM

What does it mean that HSBC is moving their SIVs to their balance sheet?

Let's start with the structure of an SIV (Structured Investment Vehicle). First an SIV has investors - like hedge funds or wealthy individuals - who invest say $1 Billion in the SIV (the equity). Then the SIV issues commercial paper (CP) and medium-term notes (MTN) that pay slightly higher rates than similar duration paper. The typical SIV, according to Fitch, uses 14 times leverage, so in our example the SIV would sell CP and MTN for $14 Billion.

Now the SIV invests this $15 Billion ($1 Billion equity and $14 Billion borrowed) in longer term notes. The idea is simple: borrow short, lend long, hedge the interest rate and credit risks - and the profits flow to the investors in the SIV.

So what does a bank like HSBC have to do with this? Usually the bank sets up the SIV, attracts the investors, manages the SIV for a fee - and there was always the appearance that the SIV CP was backed by the bank - perhaps allowing the CP and MTN to pay lower interest rates.

So what is the problem? Some SIVs invested in asset backed paper, backed by home mortgages. Even though the SIVs almost always invested in the highest tranches (with no losses to date), the market value of these assets has fallen recently (not a news flash). This means that the investors in the SIV (the equity) have taken paper losses on their $1 Billion investment.

UPDATE: Note the following NAVs are for the equity portion. A NAV of 71% means the $1 Billion equity in the example is now worth $710 million.

In fact many of the SIV NAVs have fallen substantially. From Moody's: Moody's says some SIV NAVs have fallen below 50%

Moody's [on Nov 8th] said that the average NAV across the SIV sector has fallen from 101% at the beginning of July to 71% at the beginning of November, and the shut-down of the CP market has led to realised losses in some cases.

However, the rating agency pointed out that there was significant variation between the NAVs of different SIVs, with some declining only to 90% and others falling below 50%.

Once the value of the equity falls enough (usually 50%) there is usually a trigger event forcing the SIV to liquidate the longer term investments. A forced liquidation might not only wipe out all the remaining SIV equity, but the holders of the CP and MTN might take some losses too.

This has made potential investors in CP and MTN (not to be confused with the investors in the equity of the SIV) to refuse to buy any more CP. Since there is a duration mismatch - the investments are in longer term notes, CP is less than 9 months - the SIV is stuck with a liquidity problem when the CP comes due.

To solve this problem, a bank like HSBC could explicity guarantee the CP and MTN, and this would attract investors in CP and MTN again. But under accounting rules, this guarantee means the SIV belongs on the bank's balance sheet. The structure stays the same - the SIV equity investors still take the losses - but there is no liquidation event. If the losses exceed the equity investment ($1 Billion in our example), then the bank would start taking losses.

From the HSBC article this morning:

[HSBC] insists earnings won't be materially impacted, because existing investors will continue to bear all economic risk from actual losses.

Clearly HSBC think these is adequate equity in these SIVs to cushion the bank from any losses.

Finally, to the balance sheet!

The balance sheet lists the assets and liabilities of the company. Moving the SIV to the balance sheet simply means adding the $15 Billion in assets (those longer term notes) to the Asset portion of the balance sheet, and moving the $15 Billion in CP, MTN and SIV equity to Liabilities. The new assets balance with the new liabilities, and there is no income or loss for the bank. Since the equity will take the losses first, any mark down in the $15 Billion in assets will be matched by a mark down in the liabilities - up to $1 Billion.

So what is the problem if there are no losses for the bank? There is an impact on the ratios of the bank - the reason the SIVs were off the balance sheet in the first place - and this limits other lending activities of the bank, contributing to the credit contraction.

by Tanta on 11/26/2007 12:00:00 PM

While we're on the subject of subprime reporting . . .

This is what the Wall Street Journal reported on page one on November 2:

Merrill Lynch & Co., in a bid to slash its exposure to risky mortgage-backed securities, has engaged in deals with hedge funds that may have been designed to delay the day of reckoning on losses, people close to the situation said. . . .

The SEC is looking into how the Wall Street firm has been valuing, or "marking," its mortgage securities and how it has disclosed its positions to investors, a person familiar with the probe said. . . .

In one deal, a hedge fund bought $1 billion in commercial paper issued by a Merrill-related entity containing mortgages, a person close to the situation said. In exchange, the hedge fund had the right to sell back the commercial paper to Merrill itself after one year for a guaranteed minimum return, this person said.

While the Merrill-related entity's assets and liabilities weren't on Merrill's own balance sheet, Merrill might have been required to take a write-down if the entity was unable to sell the commercial paper to other investors and suffered losses, the person said. The deal delayed that risk for a year, the person said. . . .

"Merrill has been making the rounds asking hedge funds to engage in one-year off-balance-sheet credit facilities," Janet Tavakoli, who consults for investors about derivatives, told clients in a recent note. "One fund claimed that Merrill was offering a floor return (set buy-back price)," she said in the note, "so this risk would return to Merrill."

So, basically, this article is almost exclusively stenographic reproduction of what one person who is not named said. The Tavakoli quote certainly hints that the person is either a hedgie or is just repeating what some hedgie claimed.

Today, reporteth the WSJ:

ON NOV. 2, the Journal published a page-one article on Merrill Lynch & Co. that was based on incorrect information that the firm had engaged in off-balance-sheet deals with hedge funds in a possible bid to delay the recognition of losses connected to the firm's mortgage-securities exposure. In fact, Merrill proposed a deal with a hedge fund involving $1 billion in commercial paper issued by a Merrill-related entity containing mortgage securities. In exchange, the hedge fund would have had the right to sell the mortgage securities back to Merrill after one year for a guaranteed minimum return. However, Merrill didn't complete the deal after the firm's finance department determined it didn't meet proper accounting criteria. In addition, Merrill says it has accounted properly for all its transactions with hedge funds.

An anonymous blogger would like to know the following:

1. Why does "the person" still get anonymity? "The person" either lied or passed on unverified rumors as if they were facts. Why don't we need to know who "the person" is?

2. Did "the person" call the reporter with the tip on the original story? Why don't we need to know this?

3. Is "the person" in a position to profit from a fall in MER's share price? Why don't we need to know this?

4. What's with so-called "journalism" that merely repeats uncorroborated rumors planted by interested sources who get grants of anonymity?

5. Don't believe anything you read on some anonymous blog, for heaven's sake.

(thanks, commenter!)

by Calculated Risk on 11/26/2007 10:25:00 AM

Yesterday Tanta answered the question: What is Subprime?

Tanta covers the basics of mortgage underwriting and the three Cs:

Mortgage underwriting isn’t really that difficult, which is of course why some of us have been so shocked at the extent to which lenders have been screwing it up in the last few years. ... what it’s about is just working through the complexity of the variations on three things that have been the core of mortgage underwriting since roughly the dawn of time: the three Cs, or Credit, Capacity, and Collateral. Does the borrower’s history establish creditworthiness, or the willingness to repay debt? Does the borrower’s current income and expense situation (and likely future prospects) establish the capacity or ability to repay the debt? Does the house itself, the collateral for the loan, have sufficient value and marketability to protect the lender in the event that the debt is not repaid?

There is no New Paradigm, there was no New Paradigm, there is not going to be a New Paradigm. The Cs are the Cs. What we “innovated” was our willingness to believe that we had established the Cs with indirect or superficial measures (that are, not coincidentally, cheap and fast compared to direct measures). We looked at FICOs—scores produced by computers—instead of full credit reports and other documents to supplement them. We looked at the borrower’s statement of income or assets, not the documents; when we got docs, we looked at the last paystub or the current balance of an account, not the documentation of a long enough period to establish stability of income or source of account balances. We looked at AVMs instead of full field appraisals. We read the Cliff’s Notes.

These practices have not worked out so well, of course, but my point is that they were simply “innovative” ways of answering the three C questions, not new questions.

Later in the piece Tanta explains why "we are all subprime now":

The fact is that huge numbers of people who have “prime” mortgage loans couldn’t refi or sell right now to—literally, for some of the uninsured—save their lives. They may well still be making payments on the mortgage, but they’re rapidly approaching upside-down if they’re not there yet, they’ve spent the proceeds of the previous cash-outs that kept up the lifestyle or just kept life together, and if the truth were known about credit card balances, their current FICOs probably aren’t the envy of the neighborhood either. They are, in short, subprime. They just don’t recognize themselves in the stereotype of the deadbeat serial bankruptcy filer or the undocumented immigrant or the waitress in the McMansion or whatever extreme case you can dredge up and label “typical” for subprime. They are, increasingly, “us.”

The invisible subprimers will do okay if this blows over and they don’t lose their jobs: if and when the RE market recovers, anyone who hung onto the mortgage he has will come out “prime” again. That’s the good news. The bad news is that attributing this solely to your own prudence and good judgment and inherent worth as “not one of those subprime people” is a form of delusion. Subprime is like the weather: when it rains, everybody gets wet.

This is a key point: a large number of prime and Alt-A borrowers are - or will soon be - upside down in their homes. They cannot sell (without bringing cash to escrow). They cannot refinance. The slightest financial problem and they will be facing foreclosure. And just imagine the psychological impact of making payments on a $500K mortgage when the same house just sold for $400K down the street. Collateral is one of the three Cs, and these homeowners' collateral makes them part of a growing group of "invisible subprimers".

Check out Tanta's entire post: What is Subprime?