by Calculated Risk on 12/21/2007 09:16:00 PM

Northern Trust's Director of Economic Research Dr. Paul Kasriel's model is putting the odds of recession at 65.5%: Probing the Probabilities of a 2008 Recession

Click on graph for larger image.

This is Chart 2 from Kasriel's piece:

What is the probability that the U.S. economy will fall into a recession in 2008? We would answer, 65.5%. The bases for our answer are the Kasriel Recession Warning Indicator (the trademark-pending KRWI) and an econometric technique known as Probit modeling. ... Since the late 1960s, every recession ... has been immediately preceded by or accompanied by both of the KRWI variables in negative territory. The KRWI has not given a false qualitative signal – i.e., it has not predicted a recession when one did not occur. Aside from its impressive track record in identifying recessions, the KRWI has another attractive attribute – its variables are not subject to much, if any, revisions. For a theoretical explanation of the KRWI see, The Inverted Yield Curve - Is It Really Different This Time?.

There is much more in the piece. See Kasriel's comments on the stock market (page 4, chart 4).

by Calculated Risk on 12/21/2007 06:16:00 PM

In addition to this blog, Tanta and I have decided to offer a monthly subscription email newsletter with analysis of real estate and the housing market.

The idea of this newsletter is to provide a concise overview of the real estate market - what we think you need to know - and commentary on real estate and mortgage issues. This newsletter will draw heavily on material from this blog, but will be focused on real estate (as opposed to other credit and economic issues).

Hopefully this monthly overview will provide useful background information for real estate investors, home buyers, and sellers. The price is $60 per year.

If you are interested, you can sign up at CR4RE (Calculated Risk 4 Real Estate).

Best Wishes to All.

by Calculated Risk on 12/21/2007 03:20:00 PM

From the WSJ: Banks to Abandon Super-SIV Plan

Lack of interest has led the banks to drop the plan -- known as the Master-Enhanced Liquidity Conduit, or M-LEC. ...

The banks ... are likely to issue a statement by Monday saying they no longer intend to go forward with the fund, according to the people familiar with the matter.

This just makes official (well, on Monday) what was obvious from the beginning.

by Tanta on 12/21/2007 01:48:00 PM

Apparently we're not going to have an ABX.HE 08-1 to kick around any time soon:

New York, NY- Markit, the leading provider of independent data, portfolio valuations and OTC derivatives trade processing and owner of the Markit ABX.HE index, today announced that the roll of the Markit ABX.HE has been postponed for three months. The Markit ABX.HE is a synthetic index of U.S. home equity asset-backed securities.

The new series, the Markit ABX.HE 08-1, was scheduled to launch on 19 January 2008. The decision to postpone its launch was taken following extensive consultation with the dealer community. It follows a lack of RMBS deals issued in the second half of 2007 and eligible for inclusion in the forthcoming Markit ABX.HE roll. The Markit ABX.HE 07-2 remains the on-the-run series until further notice.

Under current index rules, only five deals qualified for inclusion in the Markit ABX.HE 08-1. Markit and the dealer community considered amending the index rules to include deals which failed to qualify initially but decided against this approach at this time.

Markit and the dealer community remain fully committed to the index and will update the market as and when appropriate.

I'm actually quite touched that they decided not to just re-write the rules to qualify any old deal they could scrape up. It's so . . . unusual for anything having anything to do with mortgages lately.

I don't know why some deals failed to qualify, but looking over the eligibility rules, I'd guess that the deals were either too small (under $500MM) or had a WA FICO greater than 660. Oh well. I guess I have to change my line: we're all prime now.

(Thanks, Buzz!)

by Calculated Risk on 12/21/2007 12:06:00 PM

From MarketWatch: Fitch warns it may cut Ambac's AAA rating

The AAA rating of Ambac's bond insurance unit was put of Rating Watch Negative by Fitch, which means the agency will downgrade to AA+ in four to six weeks unless the company can boost is excess capital levels before then. A review by Fitch of Ambac's exposure to CDOs and residential mortgage-backed securities found that the insurer is roughly $1 billion short of the extra capital it needs ...

Yesterday, Fitch put MBIA on Rating Watch Negative, and then followed up by putting "173,022 bond issues (172,860 municipal, 162 non-municipal) insured by MBIA on Rating Watch Negative". We will probably see another large number of issues on Rating Watch Negative later today.

On topic, from Bloomberg: Muni Insurance Worthless as Borrowers Shun Ambac

State and local borrowers are discovering that buying municipal bond insurance from MBIA Inc. and Ambac Financial Group Inc. is a waste of money.
...
Many investment-grade munis would have AAA ratings without insurance if they were ranked the same way as corporate debt. Every state except Louisiana would be Aaa, based on the scale for companies, which ranks borrowers on the probability of default, according to the report by Moody's.

Municipal issuers are ranked on their fiscal health relative to other municipalities. Investors' increased willingness to buy state and local government debt without guarantees suggests that borrowers may not require the backing of insurance companies.
...
``Taxpayers give insurers $2 billion a year because of a dual-rating scale,'' said Matt Fabian, senior analyst and managing director of Municipal Market Advisors, an independent municipal bond research firm in Concord, Massachusetts. ``You could easily save taxpayers that $2 billion by rating them on the same scale as corporate bonds.''

by Calculated Risk on 12/21/2007 11:26:00 AM

From the Fed weekly report on commercial paper this morning, here is the discount rate spread:

Click on graph for larger image.

According to the Fed, the discount rate spread is still increasing. This is the graph released this morning.

Meanwhile, the Fed is still pouring liquidity into the market with another $20 billion TAF auction yesterday. And the Fed has announced:

The Federal Reserve intends to conduct biweekly Term Auction Facility (TAF) auctions for as long as necessary to address elevated pressures in short-term funding markets. The Board of Governors will announce the sizes of the January 14 and January 28 TAF auctions at noon on January 4.

Here is the discount rate spread graph from last week:



Clearly this indicator of the credit crisis has worsened.

Here is a simple explanation of this chart: This is the spread between high and low quality 30 day nonfinancial commercial paper.

What is commercial paper (CP)? This is short term paper - less than 9 months, but usually much shorter duration like 30 days - that is issued by companies to finance short term needs. Many companies issue CP, and for most of these companies the risk of default is close to zero (think companies like GE or Coke). This is the high quality CP. Here is a good description.

Lower rated companies also issues CP and this is the A2/P2 rating. This doesn't include the Asset Backed CP - that is another category and is even at a higher rate (see commercial paper table).

The spread between the A2/P2 and AA paper shows the concern of default for the A2/P2 paper. Right now the spread is indicating that "fear" is very high. It is actually very rare for CP defaults, but they do happen (see table 5 in the above Fed link).

by Tanta on 12/21/2007 09:55:00 AM

With a curtsey to sunsetbeachguy, we stare in wonder at an interview with the Treasury Secretary in the LAT.

On disclosures:

The key is to get the balance right and not go so far that you cut off credit and make the situation worse. The Fed has also been looking at disclosure. I think when you look at the mortgage area, it's almost a caricature of what you see in other areas. You've got pages and pages of disclosure, which doesn't mean you're getting the people good information that they can understand. It's sort of, "Everybody cover their rear end," protect themselves legally. But, I've made the case several times, with all the disclosure there should be one simple page signed by the lender and the borrower that says, "Your monthly payment is x and it could be as high as y in a couple of years." The Fed I know has done some real consumer research on this.

I also have done some real research on this. I have found that when you prepare a simple, one-page document that says, "Your monthly payment is x and it could be as high as y in a couple of years, and you can't afford that, which is why we are denying your application for credit," you call it an "Adverse Action Notice" instead of a "Disclosure." But that kind of runs into that "cutting off credit" problem.

On interests, best:

And the way I think about it is this: that historically when a homebuyer, homeowner has a problem, a default's clearly not in the homeowner's interest. And it's clearly not in the lender's interest. It's very costly; defaults are very costly. So in a normal world the two sides come together and they strike a deal. Today we're dealing with two factors that make this more difficult. First, as you know, the institution or company that made the mortgage no longer holds it. It's spread all around the world with investors. That creates a cumbersome, complex decision-making process. It's one that can be dealt with when you've got home prices rising or you've got a stable mortgage market.

Historically, homeowners had a down payment invested in the property; also, historically homeowners who defaulted knew they'd have a hard time getting credit again in the future. Having removed the downpayment and minimal credit standards, there isn't much "cost" to default for a lot of people. Furthermore, if a default is costly to the "lender," then it is surely costly to whoever the "lender" is today. Why a transfer of servicing rights would, in and of itself, remove the incentive for working out loans is still kind of hard to see. But, as Paulson notes, this incentive failure can be responsibly managed when defaults are not costly. We pay this guy with tax dollars.

The whole interview goes on for a lot longer, but I can't take any more of this. You all will have to take it apart in the comments.

by Calculated Risk on 12/21/2007 09:33:00 AM

From the WSJ: Chrysler Faces Financial Pinch, Sees Asset Sales

Chrysler LLC has slipped into a serious financial crunch just four months after Cerberus Capital Management LP swept in to save the auto maker.

At a meeting earlier this month, Chief Executive Robert Nardelli told employees the company is headed for a substantial loss this year and is scrambling to sell assets to raise cash ...

"Someone asked me, 'Are we bankrupt?'" Mr. Nardelli said at the meeting. "Technically, no. Operationally, yes. The only thing that keeps us from going into bankruptcy is the $10 billion investors entrusted us with."

Back in August, when the sale of Chrysler to Cerberus was closed, the investment banks were unable to sell $10 billion in debt and had to take the debt on their balance sheets. This played a role in the credit crunch in early August.

The banks, led by JPMorgan Chase, and including Goldman Sachs Group, Bear Stearns, Morgan Stanley and Citigroup, have tried several times to sell some of these loans, and each time the offering has been postponed. In November, the banks tried to sell a portion of the debt at 97 cents on the dollar and found no takers. With the news that Chrysler's financial situation is "serious", the value of these loans has probably dropped sharply.

This is reminiscent of the Burning Bed incident mentioned in the WSJ in May:

In a famous event dubbed the "Burning Bed," First Boston Corp. in 1989 made a $457 million bridge loan to the purchasers of Ohio Mattress. When the junk-bond market collapsed soon afterward, First Boston couldn't refinance the loan and ended up owning most of Ohio Mattress. Credit Suisse had to inject additional capital into First Boston, culminating in a full takeover.

Even adjusted for inflation, $457 Million is chump change compared to the Chrysler pier loans.

Note: a bridge loan is supposed to be temporary financing while the banks syndicate the debt. When the debt can't be sold, the bridge loan becomes a "pier loan" - a bridge to nowhere - and ties up the capital of the investment banks.

by Tanta on 12/21/2007 08:46:00 AM

What's Friday morning without a good laugh? Via our friends at Housing Doom, this solution to the RE market doldrums from a bona-fide Relitter:

Here is a moderate solution to the real-estate market:

There are more than 58,000 homes on the market. If each and every person who does not need to sell his or her home, or can wait to sell, takes his or her home off the market, the market will correct very quickly.

What we would see is all the homes that the banks have had to take back or the short-sale homes. After a few months, we would have a strong housing market. In fact, if many Realtors would educate their sellers about this, everyone would be happy.

Sellers would get closer to their asking price, buyers would feel more confident when making a decision to purchase, and Realtors would not be throwing their hard-earned money out the window to market a property that will not sell.

I honestly believe that the greed of the banks and mortgage companies are to blame for a majority of this mess. We are helping them out. But in order to keep happy customers and create a strong housing market, we all must work together.

If you are planning to sell your home in this market, think again. Waiting just a little longer could mean extra money in your pocket. - Jason Grandon, Scottsdale

You have to admit it would be a way to find out how many folks in Scottsdale don't actually have to sell. I suspect, however, that they'd both be a little disappointed later . . .

And before I get accused of going after low-hanging fruit by picking on Relitters, there's this from Bloomberg yesterday, by "a senior fellow in economic history at the Council on Foreign Relations," which may possibly be one of the most ridiculous things I've read in nearly a whole week (the op-ed, not the author's title, although that's pretty funny too). There seem to be a lot of people who are confused about where "prices" come from. Certainly this is a classic:

The whole subprime problem can be seen as a consequence of too few prices and too many deals in the first place. The price of a standard fixed-rate mortgage is too high for many families, even at today's historically low rates. The appeal of the adjustable-rate loan, never mind that of the subprime no-doc mortgage, lay precisely in that it allowed borrowers to fool themselves about the true price of the debt they were assuming.

You can, apparently, be a senior fellow of something having to do with "economics" and not realize that "loan amount" is one of the variables in =PMT. I fault the educational system: too much economic history, too little Excel.

by Calculated Risk on 12/20/2007 07:23:00 PM

Press Release via MarketWatch: MBIA Further Addresses Previously Disclosed $30.6 Billion Multi-Sector CDO Exposure

MBIA Inc. has announced that in response to media and other inquiries received as a result of information the Company posted on December 19, 2007 on its Web site relating to its collateralized debt obligations ("CDO") exposure, the Company is issuing the following statement:

The information posted on December 19, 2007 discloses no additional Multi-Sector CDO exposure. The information provides detail on the composition of MBIA's $30.6 billion Multi-Sector CDO exposure that had previously been provided in its Operating Supplement. MBIA discussed its exposure to CDO transactions with inner CDOs ("CDO-Squared") during a conference call for investors on August 2, 2007.

Standard & Poor's, Moody's and Fitch have confirmed that this information was provided to them and was taken into consideration in their recent ratings analyses. The information was also made available to Warburg Pincus prior to their entering into the previously disclosed Investment Agreement, and that agreement is not affected by this information.