by Calculated Risk on 2/07/2008 06:50:00 PM

Maybe the Goldman guys still have Tom Petty's Superbowl performance on their minds since they titled their research report today Free Fallin'.



The title says it all. The report reviews recent economic data and then concludes that the U.S. economy is probably now in recession.

by Calculated Risk on 2/07/2008 04:44:00 PM

From Bloomberg: Security Capital's Bond Insurer Loses Aaa at Moody's (hat tip jg)

Security Capital Assurance Ltd.'s bond insurance units, hobbled by a decline in subprime mortgage securities, lost their Aaa credit rating at Moody's Investors Service.

XL Capital Assurance Inc. and XL Financial Assurance Ltd. were cut six levels to A3, New York-based Moody's said today in a statement. The outlook for both is negative, Moody's said.

SCA, based in Hamilton, Bermuda, was stripped of its top ranking at Fitch Ratings last month ...

Also see Deutsche Bank AG Chief Executive Officer Josef Ackermann Says Bond Insurers Threaten Debt `Tsunami' comments today:

Deutsche Bank AG Chief Executive Officer Josef Ackermann said rating downgrades for bond insurers pose risks that could match the U.S. subprime market collapse.

``It could be a tsunami-like event comparable to subprime,'' Ackermann said in a Bloomberg Television interview in Frankfurt today.

by Calculated Risk on 2/07/2008 01:42:00 PM

A few headlines from D.R. Horton (largest U.S. homebuilder):

Cancellation rate 44%.

Housing environment is "Challenging"

Average ordered home price fell 17%.

Inventory of homes is "too high".

Cancellations high in California, Arizona, Florida, Las Vegas.

California housing market won't recover in next 12 months.

Pricing weaker than expected.

by Calculated Risk on 2/07/2008 01:06:00 PM

Dallas Fed President Richard W. Fisher spoke in Mexico today: Defending Central Bank Independence. Here are his comments on why he voted against the rate cut last meeting:

At the last meeting of the FOMC, I voted against lowering the federal funds rate—the target rate we set for banks to loan overnight money to each other—from 3.5 percent to 3 percent. The minutes of that meeting will be released on Feb. 20, 2008. It would be inappropriate for me to discuss the deliberations; however, I can give you a perspective.

I spoke earlier of [former Fed Chairman] William McChesney Martin. He famously said that the job of a good central banker is to take away the punchbowl just as the party gets going. For the past few years, we have had a raucous party of economic growth fueled by an intoxicating brew of credit market practices that financed a housing boom of historic, and late in the cycle, hysteric, proportions. With the benefit of perfect hindsight, some have argued that the Fed failed to take away the punchbowl as the subprime party spun out of control, leaving rates too low for too long and not using our regulatory powers to restrain excessive complacency in the pricing and monitoring of risk. But that is beside the point.

Now we are faced with the consequences of a process that lawyers would call the “discovery phase”: As big banks and other financial agents confess their acts of fiduciary omission and excesses of commission, credit markets have effectively de-leveraged important segments of the economy, slowing growth suddenly and precipitously. Instead of taking the punchbowl away, the Federal Reserve is now faced with the task of replenishing the punch.

Yet at the same time, we are faced with the unprecedented consequence of demand-pull inflationary forces fueled by the voracious consumption of oil, wheat, corn, iron ore, steel and copper, and all other kinds of commodities and inputs, including labor, among the 3 billion new participants in the global economy. When it comes to these precious inputs, we have no control over the surging demand from China, India, Brazil, the countries of the former Soviet Union and other new growth centers, but we know that it is putting upward pressure on prices in our economy. Economists note that the “income elasticity of demand” for food is higher in China and other emerging economies than in the United States. Many of these countries’ income elasticity of demand for oil and certain other vital commodities is greater than 1, meaning that their demand for these items will increase faster than their income. Even if growth slows somewhat in some of these important emerging economies—the World Bank, for example, projects China’s growth will be 9.6 percent in 2008, down from 11 percent last year—demand for inputs relative to the world’s ability to supply them will likely continue to exert upward pressure on key commodity prices.

We also know that the inflationary expectations of consumers and business leaders are impacted by what they pay for gasoline at the pump and food at the grocery store.

Monetary policy acts with a lag. I liken it to a good single malt whiskey or perhaps truly great tequila: It takes time before you feel its full effect. The Fed has to be very careful now to add just the right amount of stimulus to the punchbowl without mixing in the potential to juice up inflation once the effect of the new punch kicks in.

We have been hard at work trying to find the right mixture. Before the meeting last week, we had reduced the fed funds rate by 175 basis points in 18 weeks—cuts that I supported even though I did not have a formal vote. During that time, we also initiated a new system for term money that has auctioned $100 billion at rates below the official discount rate.

My dissenting vote last week was simply a difference of opinion about how far and how fast we might re-spike the monetary punchbowl. Given that I had yet to see a mitigation in inflation and inflationary expectations from their current high levels, and that I believed the steps we had already taken would be helpful in mitigating the downside risk to growth once they took full effect, I simply did not feel it was the proper time to support additional monetary accommodation.

That is two voting members expressing serious concerns about inflation.

However, it appears the market isn't listening to Fisher, or Plosser's "damn the torpedoes, full speed ahead" speech yesterday:

"Unfortunately, I expect little progress to be made in reducing core inflation this year or next, and I am skeptical that slower economic growth will help. ..."

Click on graph for larger image.

According to the Cleveland Fed, the market expectations are centered on an additional 50 bps cut in the Fed Funds rate in March to 2.5%.

by Calculated Risk on 2/07/2008 11:11:00 AM

From NAR: Existing-Home Sales to Hold in Narrow Range, then Begin Upward Trend

The Pending Home Sales Index, a forward-looking indicator based on contracts signed in December, slipped 1.5 percent to a reading of 85.9 from a downwardly revised index of 87.2 in November, and was 24.2 percent below the December 2006 level of 113.3.

And here is the NAR's forecast for existing home sales in 2008 and 2009:

Existing-home sales are projected at an annual pace of around 4.9 million in the first half of this year, rising notably to 5.8 million in the second half, and totaling 5.60 million for all of 2009.

The NAR forecasts are always amusing. The recovery is always just around the corner!

by Tanta on 2/07/2008 10:36:00 AM

Seems like a fair request to me. This is from OFHEO Director James Lockhart's testimony to the Senate Banking Committee, link brought to you by the indefatigable and industrious bacon dreamz:

The GSEs have become the dominant funding mechanism for the entire mortgage system in these troubling times. They are fulfilling their missions of providing liquidity, stability, and affordability to the mortgage markets. In doing so, they have been reducing risks in the market, but concentrating mortgage risks on themselves. . . .

The risks are beginning to take their toll. Public disclosures indicate that Freddie Mac will report annual losses for the first time in its history and Fannie Mae for the first time in 22 years. Their missions, as well as Congressional and many other pressures, are demanding that they do more and take on more risks in areas new to them – subprime and jumbo mortgages. As the safety and soundness regulator of Fannie Mae and Freddie Mac, I have to tell you that expansion of their activities would be imprudent unless the regulator has significantly more powers and more flexibility to use those powers. Given the tremendous stresses on the mortgage markets, the American people cannot afford to have Fannie Mae, Freddie Mac, or the 12 FHLBanks incapable of serving their mission. . . .

In 2006, Fannie Mae and Freddie Mac were losing market share to Wall Street private label MBS (PLS). There is a certain irony that one of the ways they prevented their market share from falling even farther was that they became the biggest buyers of the AAA tranches subprime and Alt-A of these PLS. The Enterprises’ earlier problems, OFHEO’s constraints, and the loose underwriting standards in the market made it hard for them to compete. Some observers even suggested that, due to shrinking of market share, their support of, and therefore their risk to, the mortgage market were no longer relevant.

In the last half of 2007, the PLS world shrunk to minimal levels as a result of a long list of well reported problems. As a result, even with the OFHEO constraints, Fannie Mae and Freddie Mac mortgage purchases as a share of new originations grew to unforeseen levels, rising from less than 38 percent in 2006 to over 60 percent in the third quarter of 2007. The just reported fourth quarter results of 75.6 percent are double 2006’s market share. If you add in the net increase in outstanding FHLBank advances, especially in the third quarter, the combined market share of the housing GSEs may be 90 percent. . . .

Another related change over the period was the growth of credit risk. Operational risk and to a lesser extent market risk had been the key focuses of the Enterprises and they still are extremely important with the volatility of the markets and heavy reliance on models for market and credit risk pricing. I remember listing credit risk concerns in an early presentation I did to one of their Boards. Some members were mystified that I thought it was an issue given their track record. I am afraid that was a sign of the times.

The Enterprises were then reporting credit losses of 1 to 2 basis points, a third of normal levels and now they are approaching double normal levels and climbing. Some of this growth in losses was because they lowered underwriting standards in late 2005, 2006, and the first half of 2007 by buying more non-traditional mortgages to retain market share and compete in the affordable market. They also have very large counterparty risks including seller/servicers, mortgage insurers, bond insurers and derivative issuers.

Basis points sound small, but they become important when you are leveraged the way Fannie Mae and Freddie Mac are . . .

Now, I will turn to the temporary increase in the Conforming Loan Limit (CLL) as proposed in the Economic Stimulus package. OFHEO believes any increase in the CLL should be coupled with quick enactment of comprehensive GSE reform. The CLL provision in the stimulus package would increase the Enterprises risks by allowing them to enter the “jumbo” loan market. It would increase the maximum size loan those GSEs could purchase or guarantee from $417,000, to the lower of 125 percent of median area prices or $730,000, for mortgages originated between July 1, 2007 and December 31, 2008. This change should help lower interest rates on some jumbo mortgages, but other potential implications deserve attention.

Jumbo loans would present new risks to the already challenged GSEs. The prepayment and credit risks are different than those of conforming loans. The provision also pushes the GSEs to increase their geographic concentration in some of the riskiest real estate markets. Roughly half of all jumbos are in California. Underwriting them successfully will require new models and systems to ensure safe and sound implementation. Capital also would present challenges even if all newly conforming mortgages are securitized. A $600,000 loan requires as much capital as three $200,000 loans. . .

by Tanta on 2/07/2008 10:02:00 AM

P.J. at Housing Wire reports that FASB (the Financial Accounting Standards Board) is threatening to end the arguments over "the Q election" by simply eliminating QSPEs entirely:

In an accounting standards session at this past week’s American Securitization Forum, FASB director Russell Golden told audience members that the standards board has since decided to eliminate QSPEs altogether; the focus now is now on how to best to handle the issues created by so doing.

You could have heard a pin drop among audience members after Golden said FASB would “eliminate QSPEs.”

Attempting to fix one problem kept causing other problems to pop up, Golden said. He also hinted that the recent SEC letter by chief accountant Conrad Hewitt, which apparently gave the green light to fast-track loan mods, understated the real discussions that have been taking place in private between SEC and FASB officials.

Bloomberg’s Weil suggests that FASB officials have been irked at what they saw as the SEC undermining FASB due process — a line of motiviation that I think misses the truth behind what’s really been going on.

It’s probably fairer to say that FASB had been letting sleeping dogs lie in this area after shoring things up in the wake of the Enron scandal in 2001; and those dogs are no longer sleeping — or lying down — thanks to the ARM rate freeze plan. Forced to address the issue of loan servicing, FASB apparently decided it was easier to eliminate the concept of a QSPE altogether than to try to modify the rules under which it should be allowed to exist.

It’s unclear, exactly, how a ‘Q-less’ world ultimately would affect the secondary markets; many of the details have yet to be nailed down. One thing, however, would seem to be crystal clear: loans would, in all likelihood, no longer be able to be transferred off of a lender’s balance sheet. Golden said that FASB is still working through details of a proposal in this area, however, and would want input from market participants.

At this point, I take this to mean that mortgage loan (and other asset-backed) securitizations would have to be treated as financings, rather than sales, of the underlying assets. Therefore both the assets and the corresponding liabilities would be reflected on the issuer's balance sheet, with the (presumed) effect of increasing the issuer's capital requirements as well as the cost of financing (investors would have to be compensated for the loss of the "bankruptcy remote" vehicle structure). I think we can pretty much guess what the "input from market participants" is going to be.

In case you missed this in yesterday's New York Times:

Until the banks rebuild their capital, they will not have the wherewithal to lend money and support economic growth. If banks of all sizes could regain their capital immediately and easily, it would be a tremendous benefit to the American economy.

The federal government could make this happen by entering into an arrangement with American banks that hold subprime mortgages, in which homeowners typically pay a low interest rate for two or three years then face much higher payments. Here’s how it would work: The government would guarantee the principal of the mortgages for 15 years. And in exchange the banks would agree to leave their “teaser” interest rates on those loans in effect for the entire 15 years.

This would instantly give the lending banks new capital. As these mortgages would be guaranteed by the Treasury, they would suddenly be assessed, on bank balance sheets, at their original value — and a significant amount of the banks’ lost capital would be restored. Plus, the banks would receive, from most of the homeowners with subprime mortgages, up to 15 years of teaser-rate payments.

Certainly a government guarantee of principal--with no guarantee fees, insurance premiums, or interest income to the guarantor, like those mean GSE and FHA alternatives require--would take care of the capital problem.

by Calculated Risk on 2/07/2008 09:53:00 AM

From the WSJ: Wal-Mart Reports 0.5% Rise In Sales, Below Its Forecast

Wal-Mart posted a 0.5% gain in January U.S. same-store sales excluding fuel, well below the company's 2% growth forecast. Its namesake stores had a 0.2% increase, while Sam's Club had growth of 2.1%.
...
For the fiscal year, Wal-Mart's U.S. same-store sales rose 1.4%, the lowest figure since the company began releasing such data nearly 30 years ago.

More evidence of a consumer led recession.

by Calculated Risk on 2/07/2008 01:35:00 AM

From MarketWatch: Deutsche Bank 4th Quarter Net Profit -48% On Higher Taxes, Upgrades Dividend

Deutsche Bank ... reported no write-downs related to structured products and less than EUR50 million net write-downs in leveraged finance. ... The bank also reiterated its EUR8.4 billion pretax profit goal for 2008, even though it said it expects "conditions to remain challenging in 2008."

What? No visit to the Confessional?

by Calculated Risk on 2/06/2008 11:27:00 PM

From Bloomberg: MBIA to Raise Additional $750 Million of Capital

MBIA ... plans to raise an additional $750 million by selling about 50.3 million common shares, bolstering capital in an attempt to retain its AAA credit rating.
...
``The most significant fact is that they're raising the amount of capital from what they previously announced,'' Wilbur Ross, an investor in distressed companies, said in an interview with Bloomberg TV. ``I would be astonished if they hadn't consulted with the rating agencies before they made this announcement,' he said, adding that MBIA may retain its AAA.

And from the WSJ: Rescue Plans Won't Prevent Downgrades

... some banks and investors working toward salvaging the bond insurers ... are realizing that even the best plans could require them to settle for less -- less risk, less reward and bond insurers with less-than-triple-A ratings in the future ...

The banks are trying to figure out how to commute, or unwind, their credit-default swaps, which are contracts they entered into with ... bond insurers to guarantee their portfolios of complex debt securities known as collateralized-debt obligations, or CDOs ... In exchange for unwinding the contracts, FGIC and Ambac could give the banks stakes in their companies through warrants ...

The banks, then, would share in the proceeds that the bond insurers would make as they collect premiums and wait for their existing portfolio of policies to expire, or "run off." In this scenario, the most the banks are hoping for is that the bond insurers' credit ratings don't fall below double-A ...

If some of the recent loss estimates are even remotely correct, these are just delaying tactics.