by Calculated Risk on 1/10/2008 04:37:00 PM

From MarketWatch: American Express To Take 4th Quarter Charge Of $275M Charge

American Express said it will take a fourth-quarter charge of $275 million, due to slower spending and higher delinquencies and loan write-offs in December.

by Calculated Risk on 1/10/2008 02:24:00 PM

From the WSJ by Damian Paletta, Valerie Bauerlein and James R. Hagerty: Bofa In Talks to Buy Countrywide

Bank of America Corp. is in advanced talks to acquire struggling Countrywide Financial Corp., according to people familiar with the situation.

... two people familiar with the matter said it could occur very soon. It also is possible that an agreement could be delayed or fall apart altogether.

by Calculated Risk on 1/10/2008 12:26:00 PM

From Chairman Bernanke: Financial Markets, the Economic Outlook, and Monetary Policy

Although the TAF and other liquidity-related actions appear to have had some positive effects, such measures alone cannot fully address fundamental concerns about credit quality and valuation, nor do these actions relax the balance sheet constraints on financial institutions. Hence, they cannot eliminate the financial restraints affecting the broader economy. Monetary policy (that is, the management of the short-term interest rate) is the Fed’s best tool for pursuing our macroeconomic objectives, namely to promote maximum sustainable employment and price stability.

Although economic growth slowed in the fourth quarter of last year from the third quarter’s rapid clip, it seems nonetheless, as best we can tell, to have continued at a moderate pace. Recently, however, incoming information has suggested that the baseline outlook for real activity in 2008 has worsened and the downside risks to growth have become more pronounced. Notably, the demand for housing seems to have weakened further, in part reflecting the ongoing problems in mortgage markets. In addition, a number of factors, including higher oil prices, lower equity prices, and softening home values, seem likely to weigh on consumer spending as we move into 2008.

Financial conditions continue to pose a downside risk to the outlook for growth.
emphasis added

Sounds like more rate cuts (no surprise, the market is pricing in a 50bp cut later this month).

by Tanta on 1/10/2008 10:31:00 AM

I'm a bit busy this morning disabling my telephone and hiding my mutual fund and retirement accounts, but I can get one post up.

From the CS Monitor:

A former computer developer, Thomas Banecke of Sandy Springs, Ga., spent most of the summer baby-sitting a new condo development – usually a plum assignment. But when the Atlanta condo market tanked, foot traffic dwindled to almost zero.

Mr. Banecke is now back in the computer business and is putting his real estate career on hold. In some ways, he says, the cold housing market forced real estate agents, especially rookies, to confront their own abilities, schemes, and dreams. Upfront costs, marketing, association fees, and the crucial contacts are either more costly or harder to procure than an aspiring real estate agent usually expects, Banecke says.

"This kind of thing will wipe up a whole bunch of people who thought they could do this to make a living," he says.

As for McMahon, the Atlanta agent, she still had a nice listing book and plenty of leads when she called it quits. In the end, unreliable buyers, surly sellers, and a lack of office camaraderie contributed to a decision that solidified when home sales and prices dipped. "I was waiting for a time to kind of swing out," she says. She's planning to become a high school science teacher.

One problem for out-of-work agents is that their skills may not transfer easily to other careers. California is waiting to hear on a $9 million federal retraining grant after 6,000 people lost their jobs in the housing industry since September.

But Dr. Baen of the University of North Texas is optimistic about their futures. "These people are hustlers, hard workers. They're used to getting on the phone," he says. "They'll end up in insurance, in mutual funds, in retirement planning, and commodities."

by Calculated Risk on 1/10/2008 09:16:00 AM

From AP: Capital One Cuts 2007 Earnings Forecast

by Calculated Risk on 1/10/2008 01:01:00 AM

A few people have asked me about this article from the LA Times: Lender stung by fears on finances

Delinquent loans create huge liquidity problems for loan servicers like Countrywide because the servicer becomes a middleman between the borrowers and the people who bought their loans.

When the borrower misses payments, as a record number of Countrywide's borrowers are doing now, these contracts require that the company advance those missed payments to investors until it's clear that the amounts won't be recovered.

With Countrywide having a $1.5-trillion servicing portfolio, that puts tremendous strain on its cash flow, Cannon said.

UberNerds already knew all this. From Tanta (February 2007): Mortgage Servicing for UberNerds

... the other side of “float” for the servicer is the usual requirement that the servicer advance interest (and possibly principal, although that’s less common) to the investor when it is “scheduled” to be due but wasn’t actually paid by the borrower. You’ll see, for instance, the term “scheduled/actual” used to refer to a servicing arrangement. That means that the servicer must pass through all scheduled interest each month, whether collected from the borrower or not, but only actually collected principal. Most deals these days are S/A or S/S. (A/A exists, but it’s like “with recourse,” which we talked about on a prior thread. It takes a very well-capitalized, high-risk tolerance investor to accept an A/A deal; most of the ones I see these days are old Freddie Mac MBS that are down to six loans each and just won’t die until the last payment is made.)

Having to advance scheduled interest offsets the float; it’s another way to balance the incentives. It really starts to matter when we get to this thing called “nonaccrual.” Basically, a usual servicing contract will require the servicer to advance interest until the loan is more than 90 days delinquent, after which it is placed in “nonaccrual” status, meaning it is deemed uncollectable and no more interest has to be advanced.
...
Even if the servicer no longer has to keep advancing scheduled interest, though, it has to keep paying property taxes and insurance, if the borrower isn’t paying it, until the property is sold. It also has to cover the other expenses in a foreclosure (unless the contract specifies that the investor or mortgage insurer will advance for certain costs) until the final payday.
emphasis added

You can access Tanta's UberNerd series from the menu bar: The Compleat UberNerd

I believe the top five servicers are, in order, Wells Fargo, Countrywide, WaMu, Citigroup and Chase.

by Calculated Risk on 1/10/2008 12:17:00 AM

Before visiting the confessional, Citi and Merrill are out trying to raise more capital. From the WSJ: Citigroup, Merrill Seek More Foreign Capital

Two of the biggest names on Wall Street are going hat in hand, again, to foreign investors.
...
Merrill is expected to get $3 billion to $4 billion, much of it from a Middle Eastern government investment fund. Citi could get as much as $10 billion, likely all from foreign governments.
...
Both Citi and Merrill are scrambling to nail down the details before they report earnings next week that are expected to include additional losses stemming from their exposure to mortgage-related investments. Together, these additional losses could reach as much as $25 billion.

Meanwhile, Capital One is already in line: Capital One Profit Expected to Fall Short As Loan Woes Worsen

Capital One is expected to announce today that it expects charge-offs of $5.9 billion in 2008, up from its October forecast of $4.9 billion to $5.5 billion, partly because of worsening economic indicators that include rising unemployment.

Ten billion here, ten billion there ... pretty soon you're talking real money.

For interest, I looked up the frequently quoted Senator Everett Dirksen line: "A billion here, a billion there, and pretty soon you're talking real money." Here is what the Dirksen center says:

Bottom line: the late Senate Minority Leader certainly would have endorsed the meaning behind the phrase, but it is questionable that he ever coined it.

Update, May 25, 2004. A gentleman who called The Center with a reference question relayed that he sat by Dirksen on a flight once and asked him about the famous quote. Dirksen replied, "Oh, I never said that. A newspaper fella misquoted me once, and I thought it sounded so go that I never bothered to deny it."

by Calculated Risk on 1/09/2008 07:36:00 PM

From Dow Jones (via the WSJ): Thornburg Sees Cuts In 4Q Book Value Due To Mtge Problems (hat tip idoc)

Thornburg Mortgage ... cut the book value of its portfolio by about $200 million in two months.
...
Thornburg also expects an additional $110 million decline in the market value of its adjustable rate mortgage portfolio during December, plus about $14 million in further declines due to changes in its interest rate swap agreements.

And from Bloomberg: Bear Stearns Shuts Asset-Backed Hedge Fund After Loss

Bear Stearns ... is closing a hedge fund that invested in asset-backed securities ... after the fund plummeted at least 39 percent last year.

... The fund lost more than $300 million between August and the end of November.

Bear Stearns said it would return $90 million in cash to investors immediately. The fund's remaining assets, which the company valued at about $500 million as of Nov. 30, will be sold and the proceeds refunded over an unspecified period of time ...

I wonder what investors think when the see the words "Bear Stearns" and "hedge fund"? Probably not happy thoughts.

by Calculated Risk on 1/09/2008 06:42:00 PM

This morning I excerpted from the WSJ: Goldman Sees Recession This Year. The WSJ quoted Goldman Sachs as believing the "latest data suggest that recession has now arrived, or will very shortly":

Here is the current Goldman GDP forecast by quarter:

Quarter	Change Real GDP
Q4 2007	1.5%
Q1 2008	0.0%
Q2 2008	-1.0%
Q3 2008	-1.0%
Q4 2008	0.5%

Note that they see Q4 2007 as positive. Growth appeared solid in October and November (see Professor Hamilton's calculation of the two month PCE estimate), but there is a good chance the recession started in December. The NBER dates recessions to the month.

Goldman also sees "a significant decline in profit growth" in 2008 and significant declines in house prices with "an ultimate peak-to-trough decline of 20%-25%". This decline in house prices would mean the value of existing household real estate, as reported by the Fed Flow of Funds report, would decline by $4 Trillion to $5 Trillion (yes, Trillion and I think that deserves a capital "T").

This also implies that households with mortgages would have very little remaining equity to withdraw in the aggregate (maybe about 20% remaining equity in the aggregate with a 20% price decline, and about 15% remaining with a 25% price decline). For a calculation of remaining equity vs. price decline, see: How Much Cash is Left in the Home ATM?

With tighter lending standards, 20% remaining equity probably spells the end of the Home ATM (far less mortgage equity withdrawal or MEW). This excludes the 31.8% or so of households with no mortgage debt, since it is unlikely that households with no mortgage debt will start borrowing en masse.

Finally note that Goldman sees the duration or the recession as less than one year, and therefore not as a severe recession. I tend to agree, but I think the recovery will be sluggish too, especially for employment growth following the recession, so it will probably feel like the recession is lingering into 2009.

by Calculated Risk on 1/09/2008 05:00:00 PM

St. Louis Fed President William Poole spoke this morning: Dollars and Sense.

Poole started by saying there are no new lessons here, we are just repeating old mistakes.

Will housing sector problems push the economy into recession? It is too early to tell right now, but what we can do is to examine the current situation closely and try to learn from it. Perhaps “relearn” is a better word, because the mistakes that brought us to this point have been made before. There are no new lessons here. The lessons are familiar ones that need to be more forcefully driven home and incorporated in standard financial practice in the future.

Usually I enjoy Poole's speeches, but I think he completely missed the mark with this one. First, here are Poole's Five Mistakes:

First, too many borrowers took on mortgages they could not afford. Nothing new there, except for the number of such borrowers. How could something seemingly so preventable happen? One of the main culprits was the adjustable rate mortgage, or ARM. Actually, the problem is not the ARM itself but grossly inadequate borrower understanding of this type of mortgage. The “Two/Twenty-Eight” ARM called for low initial payments for two years, which would then reset to higher levels for the remaining 28 years of the 30-year mortgage. Too many borrowers, though, did not insist on knowing just what the “higher level” would mean, and too many mortgage brokers did not provide that information in a way the borrower could understand. Other borrowers, wanting to take advantage of low initial payments, gave misleading or false information about their ability to repay. It is important to emphasize that there is nothing inherently wrong with adjustable rate mortgages, and they make sense for many borrowers. However, borrowers must be prepared for interest rate resets and able to pay higher rates. In recent years, too many borrowers were not prepared. Borrowers also need to understand prepayment penalties in their mortgage contracts. These can make refinancing ARMs into fixed-rate mortgages terribly expensive.

The problem with this "mistake" is that many of these borrowers acted rationally. They put little or no money down and basically obtained free put and call options on a house (with only their credit rating at risk). Was this really a mistake for these borrowers?

Second in our mistakes summary, mortgage brokers put too many borrowers into unsuitable mortgages. As I mentioned in a speech to a St. Louis real estate group last July, with widely held expectations of rising interest rates priced into the markets throughout the 2003-2005 period, it is difficult to avoid the judgment that these ARM loans were poorly underwritten. It was imprudent for mortgage bankers and lenders to approve borrowers who likely could not service the loans when rates rose. It is important to understand that rising interest rates were not just a risk but actually the market expectation. Poor underwriting not only jeopardized the borrowers put into unsuitable mortgages but also the brokers themselves. Numerous brokers are now bankrupt, and many survivors have suffered large losses and sullied reputations.

Third, it is surprising to me that investment banks jeopardized their reputations by securitizing these mortgages when the underlying loans were backed by inadequate or spurious information.

Damaged reputations are also casualties of the fourth major mistake: rating agencies that placed AAA ratings on many securities backed by subprime mortgages. The rating agencies seemed to have based their ratings on a backward look at default experience on similar mortgages before 2006, rather than on a forward look based on careful analysis of the likely ability of borrowers to repay in less favorable market circumstances. The reason default experience on subprime mortgages was relatively favorable before 2007 is that housing prices were rising, permitting stressed borrowers to sell their properties to repay the mortgages. The rating agencies, apparently, did not believe that house prices might stop rising, in which case the music would stop.

The final entry on our major mistake list is investors who bought those securities without conducting an adequate analysis of the underlying investments. Investors too readily accepted the AAA ratings at face value. As financial planners, you are very familiar with the cliché that “if something looks too good to be true, it probably is.” A reach for yield with inadequate attention to risk is another basic lesson that apparently cannot be relearned often enough.

It is interesting, and a bit depressing, that investment professionals made four of the five mistakes. I can understand the mistakes many financially naïve borrowers made but have a hard time understanding how so many investment professionals could have been so wrong. Many observers point to greed, but I prefer a different explanation. Shortsightedness rather than greed explains actions that led to losses of tens of billions of dollars and the failure of many financial firms.

I'd start any list of mistakes with lax underwriting standards and the lack of regulatory supervision. Why were underwriting standards so lax? Back in September, Fed Vice Chairman Donald L. Kohn addressed the causes of the housing bubble:

"... it is far too soon to pass judgment on what went wrong in the U.S. housing market and why. I suspect that, when studies are done with cooler reflection, the causes of the swing in house prices will be seen as less a consequence of monetary policy and more a result of the emotions of excessive optimism followed by fear experienced every so often in the marketplace through the ages. To some extent, too, the amplitude of the housing cycle was heightened by the newness of the subprime market, the fragmentation of regulatory oversight responsibility for that market, and the complexity and opacity of the newer instruments for transforming and distributing risk. Low policy interest rates early in this decade helped feed the initial rise in house prices. However, the worst excesses in the market probably occurred when short-term rates were already well on their way to more normal levels, but longer-term rates were held down by a variety of forces. And similar, sometimes even sharper, trajectories of house prices have been witnessed in some economies in which the central banks said they were paying more attention to asset prices."

Kohn raised three possible causes of the bubble: "fragmentation of regulatory oversight responsibility", "complexity and opacity of the newer instruments", and initially prices increased (in Kohn's view) due to "[l]ow policy interest rates".

The complexity and opacity of the new instruments (and methods of doing business) go a long way to explain the mistakes Poole lists for investment professionals. Each person - mortgage broker, rating agency, securitizer, investor - was only looking at their piece of the puzzle. I think Poole is focusing on the wrong mistakes. Kohn is much closer to the actual causes.

We can debate the impact of low policy interest rates, but a clear failure was the lack of oversight. A number of people saw the problem coming, see Fed Shrugged as Subprime Crisis Spread, but a few people in key positions failed to act, even when it was obvious that there was a systemic problem.

If we are relearning old lessons, perhaps we should remember that some oversight is good, and ideologues are dangerous to our economic health.