by Calculated Risk on 1/11/2008 04:09:00 PM

From Bloomberg: Shiller Says Bank of America May `Have Some Problems'

``There's a tendency for people to underappreciate the risk of the housing market,'' Shiller said. ``I might have a lower valuation of Countrywide than Bank of America does.''
...
``Maybe Countrywide and Bank of America are going to have some problems going forward,'' he said. ``When people see that their houses are worth a lot less than their mortgage balance, they have an incentive to default. The troubled mortgages that Countrywide already has will be followed by even more troubled ones.''

How far will prices fall? How many homeowners will be upside down? Will it become socially acceptable for upside down homeowners to walk way from their homes? What will be the impact on Countrywide (and BofA) if house prices fall 20%? If prices fall 30%? What if 10 million homeowners default over the next few years?

Those are some of the questions I'd be asking if I was at BofA. I've tried to quantify some of these numbers, and the downside risks are huge. From the earlier post:

The following graph shows the number of homeowners with no or negative equity, using the most recent First American data, with several different price declines.

At the end of 2006, there were approximately 3.5 million U.S. homeowners with no or negative equity. (approximately 7% of the 51 million household with mortgages).

By the end of 2007, the number will have risen to about 5.6 million.

If prices decline an additional 10% in 2008, the number of homeowners with no equity will rise to 10.7 million.

The last two categories are based on a 20%, and 30%, peak to trough declines. The 20% decline was suggested by MarketWatch chief economist Irwin Kellner (See How low must housing prices go?) and 30% was suggested by Paul Krugman (see What it takes).

I think Shiller is correct; the risks from housing are still underappreciated.

by Calculated Risk on 1/11/2008 03:04:00 PM

Update: Here is the Bloomberg article: Paulson Says Time `of the Essence' in Any Stimulus

A few headlines from Secretary Paulson (Brian via Bloomberg TV Interview):

U.S. Consumer faces "Challenges"

Housing is "by far" the most serious risk to the economy.

Economy slowed "rather materially" at the end of 2007.

Purpose of any Stimulus package is to help this year. "Time is of the essence"

by Calculated Risk on 1/11/2008 02:42:00 PM

From the WSJ: S&P Slashes CDO Ratings (hat tip Barley)

Standard & Poor's lowered its ratings on 149 tranches from 31 U.S. cash flow and hybrid collateralized debt obligation transactions worth a total of $8.74 billion.
...
All of the downgraded tranches come from mezzanine structured finance CDOs of asset-backed securities, high-grade structured finance CDOs of asset-backed securities, or CDO of CDO transactions collateralized by U.S. residential mortgage-backed securities.

Isn't it a little early in the day for a Friday afternoon Ratings Massacre?

by Calculated Risk on 1/11/2008 01:07:00 PM

Click on graph for larger image.

This graph shows the year-over-year contraction in the S&P 500 Index (based on monthly data).

This was suggested by Northern Trust's Director of Economic Research Dr. Paul Kasriel as a coincident indicator of a recession.

Back in December, Kasriel put the odds of a recession at 65.5%: Probing the Probabilities of a 2008 Recession. In the piece, Kasriel noted:

"There’s an old joke that the behavior of the stock market has predicted 17 out of the past 10 recessions. Chart 4, which contains year-over-year percent changes of monthly average observations of the S&P 500 stock index, shows that year-over-year declines in this stock market index are a necessary condition for a recession, but not a sufficient condition. That is, every recession starting with the one in 1948 has been accompanied by a year-over-year decline in the S&P 500 index".

This is chart 4 from the Kasriel piece.

"However, there also have been occasions when the S&P 500 index declined on a year-over-year basis without a recession occurring. Starting in July 2003, the year-over-year change in the S&P 500 index has been positive. So, there is no recession in sight despite the signal being sent by the KRWI and the likely peaking of industrial production, right? Don’t pop the champagne corks yet. As of Thursday, December 20, the S&P 500 was up only 2.95% versus year-ago (Chart 5). The S&P 500 index finished 2006 at 1418.30. So, with the S&P 500 closing at 1460.12 on Thursday, December 20, we are not far from a year-over-year contraction in the index."

Now we are there.

by Calculated Risk on 1/11/2008 10:51:00 AM

Brian asks: "How many other AAA rated companies are raising money at 14%?"

From Reuters: MBIA $1 bln debt sale may yield 14 percent-investor

A planned $1 billion debt sale by a unit of MBIA Inc may yield about 14 percent, higher than levels discussed on Thursday ... Investors on Thursday said dealers were negotiating a coupon rate between 9 percent and 12 percent, nearly double what similarly rated bonds offer.

by Tanta on 1/11/2008 10:16:00 AM

What happens when a reporter straps on a decent-sized pack of skepticism about a trade association's PRs and picks up the phone. It's like so totally cool.

Floyd "Maybe This Isn't Just Subprime" Norris in the New York Times:

And now the banks are begging the accounting rule makers to allow them to ignore a rule that has been on the books for almost 15 years. They explain that they never had any idea that they would have to restructure a lot of home mortgages, and thus had no reason to develop systems to deal with the accounting for such restructurings.

“No one anticipated a day when potentially hundreds of thousands of residential mortgage loans would be modified,” said Alison Utermohlen, an official of the Mortgage Bankers Association who has led the effort to get the accounting rules relaxed.

She said many members of the association did not have computer systems adequate to comply with the rule, but she did not identify any specific banks. . . .

The accounting rule in question, Financial Accounting Standard 114, was adopted in 1993. Lynn E. Turner, a former chief accountant of the Securities and Exchange Commission, recalls that it was enacted because of abuses by financial institutions during the savings and loan debacle. Under the old rule, banks could avoid reporting losses so long as they expected to get the principal back eventually, even if the borrower did not have to pay interest on the restructured loan. The rule put an end to that.

Or at least it put an end to it for most types of loans. These banks live with F.A.S. 114 for their commercial mortgages and corporate loans, but according to Ms. Utermohlen, they don’t have systems in place to do the calculations for large numbers of restructured residential mortgage loans.

The calculations, it turns out, are not that complicated. You could do them with a decent financial calculator, or an Excel spreadsheet. But the banks argue that would take too much effort, given the volume of loans likely to be restructured. “This would be extremely time-consuming and would likely involve additional staff dedicated to this purpose,” Ms. Utermohlen said in a letter to the Financial Accounting Standards Board this week.

Will the banks win this argument? It appears to be one that they want to win without having to actually admit that any specific bank has a problem at all. I called five members of the Mortgage Bankers Association that are represented on the committee that Ms. Utermohlen said she worked with: Citigroup, JPMorgan Chase, Bank of America, Countrywide Financial and Washington Mutual. Countrywide said that its computer systems were adequate to comply with F.A.S. 114, but that it felt it would be “less burdensome from an operational standpoint” if the rule could be ignored. None of the other four told me whether their systems were adequate.

Thanks, Floyd, for joining the team. Whenever they're going out of their way to look stupid ("we have no one on staff who can actually use Excel"), the pea is under the other shell. And yes, it is always worth asking why we give bank charters to people who can't discount a cash flow with both hands and a flashlight.

by Tanta on 1/11/2008 09:55:00 AM

I'd have enjoyed "Disorderly Conduct," but maybe that's the suit that follows against the servicing operations. From the Cleveland Plain Dealer (thanks, W.H.!):

Cleveland Mayor Frank Jackson took aim at Wall Street on Thursday with a lawsuit against 21 major investment banks that he said have enabled the subprime lending and foreclosure crisis here.

The one-of-a-kind suit, filed in Cuyahoga County Common Pleas Court, accuses venerable institutions such as Deutsche Bank, Goldman Sachs, Merrill Lynch and Wells Fargo of creating a public nuisance.

Jackson contends the companies irresponsibly bought and sold high-interest home loans. The result: widespread defaults that depleted the city's tax base and left entire neighborhoods in ruins.

City officials hope to recover hundreds of millions of dollars in damages, including lost taxes from devalued property and money spent demolishing and boarding up thousands of abandoned houses.

"To me, this is no different than organized crime or drugs," Jackson said in an interview with Plain Dealer reporters and editors. "It has the same effect as drug activity in neighborhoods. It's a form of organized crime that happens to be legal in many respects."

by Tanta on 1/11/2008 07:58:00 AM

LONDON (MarketWatch) -- Bank of America said on Friday it's buying Countrywide Financial for $4 billion, confirming rumors that first emerged Thursday, in a move that will make it the top mortgage lender and loan servicer in the U.S. . . .

Terms of the deal call for shareholders of Countrywide to receive 0.1822 of a share of Bank of America stock in exchange for each share they own.

At Thursday's close, that values Countrywide at $7.16 per share -- lower than the $7.75 closing price after news leaked of a possible deal.

Countrywide shares fell 15%, or $1.22 in pre-open trading Friday, to $6.53.

The purchase is expected to close in the third quarter. It's expected to be neutral to Bank of America earnings per share in 2008 and lift EPS in 2009, excluding merger and restructuring costs.

Bank of America expects $670 million in after-tax cost savings in the transaction, fully realized by 2011.

by Calculated Risk on 1/11/2008 12:52:00 AM

From the NY Times: Giant Write-Down Is Seen for Merrill

Merrill Lynch is expected to suffer $15 billion in losses stemming from soured mortgage investments, almost double its original estimate, prompting the firm to raise additional capital from an outside investor.

The whisper number just keeps getting bigger. Merrill reports next week.

by Calculated Risk on 1/10/2008 07:31:00 PM

Here is a graph of the Fed Funds rate, inflation (as measured by Cleveland Fed median CPI), and the unemployment rate since 1990.

Click on graph for larger image.

The inflation rate is the Cleveland Fed median CPI and is a year-over-year rate - so it is a lagged series.

It's not unusual for the YoY inflation rate to be rising as the Fed cuts rates. Usually, as the economy weakens, the inflation rate will fall. That is the current expectation of the Fed.

Note: The graphs shows the Fed Funds rate at 3.75% at the end of January; that is what the market expects following Chairman Bernanke's speech this morning.


Source: Cleveland Fed, Fed Funds Rate Predictions

The market expectations are now solidly for a 50 bps rate cut on January 30th.