Friday, August 31, 2007
Outstanding Mortgage Debt Perspective
Here is where you can get the FRB statistical supplements. Select the year, then the month you want. Then select Mortgage Debt Outstanding under RE (1.54). Please note the following figures are in millions.
end of 2002: 8,245,339
Q1 2007: 13,549,040 (+ 5,303,701 million, or 5.3 trillion)
1-4 Family: end of 2002: 6,244,957
Q1 2007: 10,426,390 (+ 4,181,433 million, or 4.2 trillion)
Keep in mind that the outstanding federal debt is estimated at about 8.9 trillion.
Guess what - quite a bit of this debt is going to be written off. The income isn't there to service it, and the value isn't there to sell the properties serving as collateral for this to recover all of the principal. The American population doesn't have the income to pay all of the interest and principal back. .Here's a chart of real disposable personal incomes from 2005 to 2007. Needless to say, the recession years from 2001 - 2003 were bad for disposable income.
Here's another. Note that this chart does not begin at zero and that the 2005-2007 curr average change in real disposable personal income was less than $2,000 in real terms. Now the outstanding mortgage debt above is not shown as real. The longer it is held, the more it depreciates in relation to real income. To really get the effect, you have to be able to hold on for 5-10 years in this environment.
Don't forget that this debt was piled up as the largest cohort in the population, the boomers, are moving into their retirement years. They have a lot of it, and they are generally the ones who have the wealth to pay it off. But they don't have it all, and paying it off will reduce their spending.
It is important to understand the unequal distribution of weath. Good free economics papers can be found at Levy Economics Institute of Bard College.
Debt is distributed far more evenly than wealth. See Levy I Working Paper 502, 2007 (pdf, 50 pgs). Try page 12. In 2004, the top 20% of the distribution had 84.7% of the net worth, and 92.5% of the non-household wealth. In 2003, they had about 57% of the income. During the housing boom homeownership reached nearly 70%, with its recent average being around 65%.
In 2004, the bottom 40% had pretty much no wealth and only 10% of the income. Do you catch the discrepancy? Note that there is a group of retirees that own their own homes but have quite low income. Their positions have not largely been improved by the home price inflation, which has primarily either passed their areas by or boosted their property taxes and insurance enough either to eject them from their home or to force them to borrow against it.
Needless to say, burdening much of that bottom 40% with high mortgages will turn out to have been dumb. My guess is that homeownership is due to roll back below the 65% recent average. My point is that the only way you can collect from the bottom 40% is by taking their earnings, and if you do, you produce a depression.
So all the talk about bailouts is irrelevant to the larger picture. There are some homeowners who are only missing by a little because of loans with bad terms. But the solution for a great many will be to exit stage right.
Thursday, August 30, 2007
Credit Crunch Data
Median Price Now: $525,000
Median Price 4/06: $579,666
% Change: -9.4%
% Change last 3 months: -2.8%
Median Price Now: $620,000
Median Price 4/06: $694,833
% Change: -10.7%
% Change last 3 months: -4.5%
Median Price Now: $389,900
Median Price 4/06: $435,000
% Change: -10.4%
% Change last 3 months: -4.7%
Median Price Now: $375,000
Median Price 4/06: $439,500
% Change: -14.7%
% Change last 3 months: -6.0%
Median Price Now: $490,000
Median Price 4/06: $537,666
% Change: -8.9%
% Change last 3 months: -3.0%
Median Price Now: $597,500
Median Price 4/06: $654,663
% Change: -8.7%
% Change last 3 months: -0.4%
(note that the loss at the 75th percentile in the last three months is 4.0%)
Median Price Now: $665,000
Median Price 4/06: $739,333
% Change: -10.05%
% Change last 3 months: -2.9%
Median Price Now: $725,000
Median Price 8/06: $769,166 (***earliest available)
% Change: -5.7%
% Change last 3 months: -2.9%
Generally, real losses will be more than are shown in the listing prices. Consider these as a floor. Prices in some areas have been declining for considerably longer than the interval documented.
Other places of note:
Salt Lake City's flippers abscond. 3 month median price drop is 8.5%.
Median Price Now: $399,950
Median Price 8/06: $479,930
% Change: -16.7%
% Change last 3 months: -7.0% (***some of this is due to a change in mix, but prices are collapsing)
Hmmm. My guess is that calls in Washington for bailouts will continue to escalate.
Austin in Texas is still rising. Florida is generally worse off than California and the decline there started earlier.. NYC and Long Island are now falling. Boston had begun to recover, but the credit crunch turned that around in a hurry (-10.25 since 4/2006, and -5.4% in three months). Portland, Oregon's happy days are over.
Raleigh, NC, took a dip and is now rising, but this is an artifact of new building; actual pricing there is under pressure with falling sales and rising inventory. Still, it shows what a reasonable market should look like. What is the difference? Affordability. Compare the median price/median income ratio for different areas, and abruptly reality bonks the holder of the piggyback mortgage on the head. Atlanta looks good, but my friends, there are plenty of neighborhoods which are more than 10% down.
There are many areas of tragicomedy that are not documented in Housing Tracker. For example, New Jersey hardly makes an appearance, yet it is slated for despair, fear and housing horror in direct proportion to its state of delusion, which is massive.
The biggest question that all this presents to me is what happens to public financing in bubble states? New Jersey is facing a fiscal crisis of no mean proportions. It's not that there are no buyers - I looked up the housing prices for this area, and laughed myself silly. Compared to incomes, the property "values" are wildly disproportionate. When you look at the taxes on these things, you realize that the properties don't sell because no one can afford them. A lot of people couldn't afford to pay the property insurance and taxes on homes in the higher-priced areas if they were given to them as a gift!!!!
Wednesday, August 29, 2007
The states that I get the most business from are California and Florida. I have received several calls from brokers in Michigan and Georgia, but nobody sending any business from those two states yet. If you don't include the clients that come to me with 48 hours before a sheriff sale or the clients that have Option One as their current lender (Option One will allow a short-sale, but not a short-refi), my success rate has been around 80%-85%. If you include the rest I am more like 70%-75%. Like I have said before, these lenders that are foreclosing on these people do not want to go through a foreclosure. It cost them a lot more money to foreclose, than taking a cut in payment on a short-payoff (whether it be a short-sale or a short-refi). Most of the time, especially in a declining market area, these houses are sold at auction and nobody shows up. which in turn, just creates another problem for them, by having an empty house sitting on their books, that they have to maintain and try to sell through a realtor. It's a lot easier for them to work a short-payoff and be done with the property. Last, you asked why would any lender do a foreclosure bailout in a declining market? I really don't have an answer for you. But, if you look at where probably 90% of the hard money lenders do business, it is California and Florida.I don't know anything about this guy and I am not recommending him, but I have heard of many types of unusual accommodations for buyers. Most borrowers who did not commit fraud will likely have success talking to the lender themselves, as the person posting writes himself.
The bailout proposals are all flawed. The reality is that lenders have to work this stuff out themselves, and they will for most loans that have some rational relationship to the the borrower's income.
Tuesday, August 28, 2007
There are very interesting comments by Rob of ExurbanNation at the post below. If you ask a question over at his blog I bet he'll answer. I've been following him for a while; he's very analytical and rigorous in his thinking.
Conference Board consumer confidence for August took a drop. Current situation dropped from 138.3 in July to 130.3, and future expectations dropped from 94.4 to 88.2. What's notable about the current situation drop is that gas prices continue to come down and extremely high food prices are being slightly mitigated by changes in supply and brands in the supermarket. So this represents another force creeping into the equation, and I doubt most of it derives from the credit crunch. I think consumers are beginning to see indications of weakness in the general economy.
Case Shiller numbers came out and showed hefty drops for home prices. Of the "official" numbers, Case Shiller is by far the best. But only their 10 city index has much of a history, and the index lags. Housing Tracker is actually better to see immediate trends, because it deals with list prices on the MLS rather than sales prices. As I wrote yesterday, the changes in financing availability and underwriting terms are distorting median price computations because of the shifts in levels of homes sold and in areas of homes sold. Case Shiller figures same house sales, so it is immune to that distortion. However, Case-Shiller is a lagging index and it also smoothes out the curve, nor does it cover anything except single-family housing. OFHEO is pretty useless at the current time, IMO. A couple of years ago it diverged from reality, and it's been diverging ever since. With the restoration of more careful appraisals, it will gradually come back to reality, but it will be a while.
Howard at Oraculations pointed me to John Mauldin's article on the credit crunch. I thought the explanations were very good, especially of the dynamics of the MBS-CDO problems. Start with Howard's post here, because Mauldin's stuff is long. I do want to caution that the problems with commercial credit are more extensive than just the aspect Mauldin discusses. From top to bottom, there are major problems. There are problems with many leveraged buy-outs, stemming from mostly the irrational expectations about the amount of debt that companies can carry. There are problems with credit-rating of firms (Mauldin's comments about the role of the risk-rating firms are apt; they are the driving force behind the current panic that just ended). There are big, big problems with some recent commercial mortgage packages. There is no stone you lift up under which you do not find some unpleasant critters.
More about the credit ratings firms:
These are outfits like Moody's, S&P & Fitch. The function of these firms is to evaluate the creditworthiness of companies and various bonds or other debt obligations that will be traded. They have fallen down on the job severely. The worst of it is that in our regulatory system, the ratings of these NRSRO's are given weight. What decides what entity can hold what type of obligation, or how transactions are risk-weighted, are the ratings that these firms have assigned! So if they fall down, the entire regulatory system becomes less and less effective. All the checks and balances basically become exercises in futility.
The problem is that the system does not allow for competition. Suppose I have a yummy lot of ABS (asset-backed) up for sale. I want to tranche it out and sell it for the maximum. I pay one of these firms to look the pool over, tell me how to structure the tranches for maximum ratings, and then slap their ratings on the various tranches that will be sold to investors. I don't pay two of them, and I can shop around, so there is clear conflict of interest. There is no non-interested party rating this stuff. Now one can feasibly argue that since their entire business was based on the viability of their ratings, the ratings firms would have to be crazy to drop their vigilance. It is, in effect, the same thing as a car company selling cars that tend to fall apart within three months. However, just think about the Big Three automakers in the US, and you will see that this can and does happen.
The short-term crisis is over. It was generated by Paribas announcing that it had no idea what the heck its funds were really worth, and closing them for a period to figure out. Paribas reopened its funds, and the crisis in ABCP (short term asset-backed paper) is now largely resolved. But the underlying crisis will play out for over a year. The reality is that the ratings of a lot of traded securities mean very little, so now before buying or selling the values have to be recalculated. You can see how that would seize up the credit markets in a hurry; it takes a long while to do it, and the more complex the debt instrument is the longer it takes. When no one knows what's going to happen, the revaluations incur a lot of uncertainty, which also affects pricing.
Treasury seems to be accepting the investment graded MBS paper at 85% as collateral for loans, so that's how the short-term crisis was abated. That action set a floor for the short-term market value of this paper. From here on it will have to be reanalyzed if you want to hand it off at a higher rate than that. The net effect was to surgically remove a lot of money from the financial system. See Shadowstats & M3.
The process of separating the sheep from the goats has begun, and some credit terms are already loosening. But risk premiums and avoidance are now firmly back as factors, and this will cause a big drop in commercial construction and renegotiation on everything from LBOs to the marketing of ABS and MBS. From here on out, the better deals will be distinguished from the dicier deals. It will probably work as at least a three-step downward staircase. The first step is the one we just took.
Monday, August 27, 2007
Home Sales And Freight
These numbers, btw, will continue to be revised for months to come. Generally the revisions are not that great.
Freight dropped 0.7% from May, and 3.4% from June 2006. This is a YoY staggering drop, the largest June drop in the history of the freight index. If you go to Table 10 at the end of the release, which shows freight by quarters, you will see that the pattern shown in 2007 is even weaker than the pattern shown in the first two quarters of 2001. This bodes poorly, and is one of the reasons I am so sure that we are in an inflation-masked recession. Freight is a reflection of primary economic activity.
Passenger TSI is really a diffusion index. In the early stages of a recession some business travel related to sales often rises. By the time it falls, usually businesses have begun to feel the recessionary squeeze and are cutting back on sales. So this is between a second and a third-order effect. In June, passenger TSI fell 0.7%. For 2007 to date, this is the sequence for passenger TSI:
Jan..:-0.1About as classic as you can get, and also a pretty clear indicator of recession. The 2001 recession really began in Q4 2000, and passenger TSI went negative in Q1 2001, so we are a quarter or two later according to this stat. (Note, because of 9/11, Q3 and Q4 2001 TSI is distorted and of no use for comparison).
Now to existing home sales: The most electrifying figure is that adding single-family and condos together, months of supply at the current annualized sales rate reached 9.6 months. Let's just say that no one who still remembers how to blush can maintain that home prices aren't going to continue to drop.
Single family sales dropped 8.3% from the previous month (actual numbers) and dropped 6.5% from the previous July. At the current pace, it would take 9.2 months to sell all of the homes currently on the market, up from 8.6 months in May and 9.0 in June.
Condo sales rose 9.5% from the previous month (actual numbers) and dropped 3.6% from the previous July. At the June sales pace, it would take a staggering 11.9 months to sell the condos currently on the market, up from 9.8 months in May and 10 months in June. Words kind of fail me here; it's difficult to characterize this debacle.
Part of the problem is that foreclosures and forced sales due to impending default and foreclosures are now pushing way more homes on the market. Absolutely every bit of objective evidence seems to show that more and more homes are due to be forced back on the market by resets and recasts for several years. It is mind-boggling to contemplate the situation. We have a sharply reduced pool of buyers due to tightened underwriting and appraisal standards, combined with rapidly growing supply. If no new home were built in the US for a year, market supply would probably continue to rise for the entire year just because of the number of individuals who must sell their homes. We are also in the early stages of recession....
Both condo and single-family sales patterns show that the market in the NE is actually recovering somewhat, and that the market in the South has taken another downturn, while the West is tanking to a historic degree.
Given these conditions, many homes in the West are likely to lose about 35% of their value from the peak. The situation depends on neighborhoods. The worst losses will be seen in the recently developed areas and neighborhoods, whereas the areas with older housing will hold their values better.
The New Home sales report is of almost no use whatsoever. Most numbers on this report are not statistically significant. About the only number that is statistically significant is the YTD 2006/2007 sales comparison, which still shows a drop of over 20%. Also, the fact that the time on market rose again in the last report to 6.1 months indicates that the situation for new homes isn't stabilizing.
Due to very high cancellation rates in the last year and a half, inventory figures in the new home sales report are meaningless. If a sale is ever recorded, it drops off the report entirely, and is not pulled back into the figures if the sale is cancelled and the home comes back on market. After months and months of this, the inventory of new homes for sale is meaningless, because the number of new homes for sale back on the market grows each month. The other side of this aspect of the New Homes sales report is that the sales of these new homes aren't recorded when they finally do go through. The best remaining indicator on that report is how long the new homes have been on market, because of course the homes still being tracked by Census are competing for buyers with the homes not being tracked by Census. When that number stops rising, we can claim that the new home market is stabilizing.
The serious disruptions in the mortgage market have now extended from subprime to Alt-A and conforming jumbos. However, the latest set of "adjustments" is not reflected in either of these reports. As daunting as they are, next spring we may be looking back at this period wistfully as a period of relative stability.
The housing market situation is severe enough that median and average sales figures mean nothing anymore. The distortions in the market compared to a year ago mean that shifts in sales patterns from one region to another and shifts in buying mix (move-ups compared to first-time buyers) are what is being shown in these figures rather than price changes.
For price changes, your best source is Housing Tracker. This provides listing prices for a number of metro areas. The drops shown are real, and always understate the real changes in home values. Many homeowners who must sell persist in listing delusionally high prices. Most of the home buyers since the beginning of 2005 who didn't make more than 10% downpayments are now underwater; many of the refinancers are too. And we have several years to come in which home prices will continue to fall.
A factor few have considered is that the prices are declining and due to decline most in the areas with the highest home values. The proportionate effect on lienholders is therefore more severe than a cursory look at the stats would suggest, because the areas in which prices are stable or rising have very low average mortgage amounts, and the places in which prices are collapsing have high relative loan amounts.
For a display of abject journalistic stupidity, read Kevin Hassett's The Housing Market Crisis May Already Have Passed. The cluelessness demonstrated is why I will always find paying work, although I doubt journalism is in my future.
It disturbs me very much to see those writing in the West, who are in very little danger, making such extreme and illogical arguments. It appears that individuals are willing to throw out the Constitution and the history of it without a second thought.
History shows patterns of economic distress in human populations which produce social distress, upheaval and often a targeting of foreign groups within a country. The irrationalism of Communist and other forms of "right-thinking" are reemerging in the right and conservative groups now. This is not a favorable social development, because the US is moving into bad economic times and certainly will continue to deal with problems and attacks from radical Muslims.
I argued over there, but I see very little positive developing in our own culture. We all should think about Obama's idea that we should pull out of Iraq and attack Pakistan; we're fools if we allow ourselves to be dehumanized by pure fear of raving religious nutcases. The truth is that any culture which assigns worth and rights to individuals based not on what they do but on their membership in some sort of group cannot harbor and nurture the humanistic principles of the west.
We had better all be looking in the mirror before it's too late.
Friday, August 24, 2007
Really Strong Durables Report
The remarkable strength of this report is that it shows depth, and shipments are now rising, which is a very encouraging sign.
After two disappointing months, primary metals new orders were up 7.9% and shipments were up 1.5%. Fabricated metals rose as well, though not as much. New orders and shipments for machinery rose, after two months of declines.
The remaining weakness is largely in computers and related, which is natural enough. Those numbers correlate well with opening of new establishments, and retail growth should be slowing which should depress those numbers.
To fully comprehend the exceptional strength of this report in comparison with recent trends, get the entire report at the link above and compare this month's figures to the two prior months and to the 2006/2007 YTD numbers.
I feel more sure than ever, although I cannot prove it, that the B/D models are causing BLS manufacturing related employment to be understated in recent months. The recent reads on the Japanese and German economies have showed some disappointments in growth, so I think this report may represent some gains for the US in heavy production versus those economies. The driving force is probably helping the US to gain share.
The necessary move transition away from a consumer-led economy and back to an economy based on fundamental production may be well underway. This is a strikingly healthy report, and no one can fairly accuse me of relentless, heedless optimism.
Thursday, August 23, 2007
Dummies, Here's How You Do It
The Aug. 20 letters from the Fed to Citigroup and Bank of America state that the Fed, which regulates large parts of the U.S. financial system, has agreed to exempt both banks from rules that effectively limit the amount of lending that their federally-insured banks can do with their brokerage affiliates. The exemption, which is temporary, means, for example, that Citigroup's Citibank entity can substantially increase funding to Citigroup Global Markets, its brokerage subsidiary. Citigroup and Bank of America requested the exemptions, according to the letter.This will cover the short-term paper, but is it a good idea? Now they aren't subject to Reg W. The exemption goes up to 30% for Citi, and is only in effect while the special discount window provisions are in effect. They say they have to be overcollateralized. End update.
On August 21, FRB published an extremely relevant legal interpretation relating to a question about the appropriate risk-weighting for oh, say, boat loans used as collateral to get cash. Pdf, 4 pages. Naturally this question was presented by a legal firm, so that no bank had to ask the question.
Normally such items would be risk-weighted at 100%, but not to worry, it turns out there's all SORTS of circumstances under which they would qualify as 20%. Or, what the heck, ruminates the FRB, if you really feel it's good stuff, why bother to risk-weight at all? Read the interpretation, and consider selling your bank stocks. (Full disclosure, yes I have some and no I have not shorted any.)
(Risk-weighting is relevant because the higher the risk-weighting, the more the bank's reserves must be increased to compensate under regulations.)
Trendy, Tranched and Intransigent
Treasury yields have stabilized to a degree. Everyone expects the Fed to cut, and is just debating how much the cut will be. Commercial paper has taken a determined step down and is staying there. Asset-backed is definitely last year's fad, and the trendy traders of today wouldn't be caught dead in it. Look at the outstanding commercial paper chart. That is a whole, whole lot of money that's got to come from somewhere:
Citi bought into Countrywide, and that seems to have infused the stock markets with hope. A measly 2 billion doesn't go very far in light of the graph above. The realization that the Fed is waiting for those who created the problem to fix the problem also seems to be settling in. That will tend to curb market enthusiasm. I may be wrong, but whenever I think of the year to come, I feel a deep certainty that the need to invest retirement savings will prevent stocks from collapsing very severely. Weaker companies could take very severe hits, but cash-flowing decent enterprises are almost bound to do well. In comparison to say, housing, they'll look pretty good.
On the lower level, down where real people live, things look a little rougher. The estimate is that about 40,000 people just lost their jobs. More are sure to come. Lending does seem to be tightening up quite a bit for some smaller businesses, which is not a good sign for jobs.
We won't see the events of the last week show up in the initial claims report for another couple of weeks. The current one is for the week ending August 18th, and for continuing claims, the week ending August 11th. The continuing claims component has showed further signs of weakening over the last few weeks, and SA initial claims have been gradually inching up for weeks. They stayed at 303,000 for two weeks, then have gone 309,000 > 316,000 > 322,000 > 322,000. Over the same period the four week moving average (SA) for continuing claims has barely moved, although it remains almost 100,000 over last year's average. Continuing claims are a better assessment of employment conditions than initial claims, especially in an economy in which non-covered employment has become so common. There could be tons of non-covered jobs out there which are absorbing covered layoffs, so until the continuing claims number breaks out from the present range I am not going to see initial claims rise as significant.
Last week's advance initial claims was 322,000, the same as this week's. But last week's was revised up to 324,000. The four week continuing claims average has been running about 95,000 more than last year's for over a month, and we probably will see that break out and move up further in early September.
The reason I expect a rise in continuing claims is that the money that's coming out of asset-backed and other commercial paper has got to come from somewhere, so the money that a lot of businesses rely on is going to evaporate in the short-term. If you haven't got it, you aren't going to advance it. This economy was too narrowly balanced not to feel the effects.
We'll see. I hope I'm dead wrong. One positive is that the non-financial is feeling it less, so working credit for some of the manufacturers looks stable.
Tuesday, August 21, 2007
We Tried To Drive Them Crazy...
"I'm going to college next year," says Fiedler, who will attend Drexel University in Philadelphia. "Not the cheapest thing nowadays. Money isn't the most important thing, but if something happens, it can turn into it."Not only are most of them happy now, but 62% think they'll be even happier in the future. With these generally realistic outlooks, that seems like a good guess.
In case you have more than $100,000 in any one bank, you may find the official deposit insurance calculator useful. Include the beneficiaries and use the walkthrough button.
Monday, August 20, 2007
Everything Goes Splat?
AFAICS, everything's gone splat. Unless the Fed fiats some buckaroo reserve value instruments in the form of Treasury instruments (the gold of the current era), TAPS is playing. And we'll need the Amazing Grace too.
There are just about no takers for non-Fannie loans in the marketplace right now; in another week the thing will have locked up tight.
H.3 Aggregate Reserves. In two weeks (Aug 1 - Aug 15) excess depository reserves moved from 1574 million to 9346 million. Surplus vault cash went from 14154 to 20271. I assume some is sitting in coffee cans and safes also; hopefully not too much.
I assume the better psychiatrists will be booked up too, so let me recommend Isle Wars Pro by Soleau Games. The shareware version is free, and there is something about conquering the world a few times with your morning coffee that steadies the nerves.
The Great Unwind Continues Apace
You can't change market mechanics by cutting the bank discount rate. Commercial paper:
100 basis points = 1%, so the riskiest category of paper continues to become more expensive. Note the previous highs in 2001/2002 - and note that the spikes (red lines only) were discontinuous at about 1 percentage point back then. The discount rate was dropped to 5.75 so it remains to be seen if that will put a cap on this rise. The total outstanding graph will be updated on Wednesday.
If you look at the first table at the link above, A2/P2 nonfinancial was still cheaper than AA Asset Backed at 15 days, so some juggling was still occurring. The entire 1-90 day durations for AA Asset backed and A2/P2 nonfinancial continued at a premium above the discount window rate of 5.75%. In theory one could make quite a bit of money by using that spread, but of course you have to offer collateral to the Fed and if the commercial paper is not paid back you could incur a loss on the deal, so a continuing premium is a commentary on perceived risk.
T-Bill yields show that the Fed's action did create an expectation of more stability past the six month/1 year mark. Compare the 8/16 yields with the 8/17 yields. Prices on the shorter term bills continued to rise after the discount rate drop on Friday.
In the meantime, WalMart is raising money while it can do so cheaply:
Fitch Ratings assigned ratings of 'AA' to Wal-Mart (NYSE:WMT) Stores Inc's new 5.8 pct 500 mln usd senior unsecured notes due 2018 and 6.5 pct 2.25 bln usd senior unsecured notes due 2037.That is 2.75 billion WalMart is raising for petty cash or petty share repurchasing cash. 10 vs 30 equates to a 70 basis point cost for the longer term.
The proceeds from the issues will be used for general corporate purposes.
Wal-Mart has repurchased about 2.5 bln usd of its common shares in the last six months, and Fitch expects that the company will continue its share repurchase activity in the second half of this year.
However, credit metrics are expected to remain steady at current levels, Fitch said.
But even if you can't change the mechanics of the credit market, you can restore liquidity. Liquidity doesn't protect against higher borrowing costs and lower credit portfolio valuations, but it does restore the ability to move the stuff at repriced values. You need time to do this, so it is essential to protect against a lockup that would force additional defaults (on commercial paper) where the ability to service the debt actually does exist. Thornburg, Luminent and Delta all got some money:
Thornburg Mortgage Inc., forced to stop taking home-loan applications earlier this month because of a cash crunch, said it sold $20.5 billion of mortgage-backed securities as part of a plan to return to ``business as usual.''The Dow has been flattish today but I suspect that is because oil and natural gas is falling as a result of Dean's track. Consumers will celebrate; speculators on disaster will mourn. Fannie Mae is selling 3.0 billion of 3 & 6 month benchmark bills on Wednesday.
The sales will result in a ``capital loss'' of about $930 million this quarter, the Santa Fe, New Mexico-based company said today in a statement.
Luminent Mortgage Capital Inc., an investor in home-loan securities, lined up about $125 million today from Arco Capital Corp. Delta Financial Corp., a subprime residential lender, found investors last week to provide $70 million.
Update: From The Housing Bubble Blog, reality rolls into the NYC area. The funniest thing about this article is the caption CNNMoney saw fit to run under the headline "The subprime mortgage collapse isn't just threatening the market for low-end homes; it's also afflicting luxury homes, reports Fortune's Jon Birger." I am not sure the individuals discussed in the article would like the implicit characterization:
What could the collapse in the subprime mortgage market possibly have to do with whether Dr. Jeffrey and Madeline Stier get full price for their four-bedroom house in the wealthy New York City suburb of Larchmont?The rule about not walking the market down is just as true for higher end homes as it is for those possum-infested subprime homes that Bloomberg was worrying about a few weeks ago. In fact, it's even more true, and that's why Thornburg is selling chunks of its holdings at a discount. Maybe we should have a competition for how long a precipitious drop in higher end home prices can be described as "the subprime mess".
...six months after the Stiers first listed it for sale at $2.5 million -- a price only slightly above what comparable homes had been selling for -- the house remains unsold. Tired of waiting, the Stiers finally capitulated and recently dropped their asking price to $1.99 million.
The shakeout has already begun, maintains Diane Saatchi, a real estate agent who specializes in multimillion-dollar vacation homes. The head of the East Hampton, N.Y., office of the Corcoran Group, Saatchi says it's no coincidence that several of her sellers agreed to lop hundreds of thousands of dollars off their asking prices the same week that jumbo rates pushed past 7%.
She's now predicting a 20% price decline for all but the most expensive Hamptons homes (the superrich don't care about mortgages). Says Saatchi: "More and more, this feels like a correction."
The article is excellent and clearly explains the situation, but the refusal to concede that irrational valuations prevailed at the top of the market even more than at the bottom of the market is a bit odd. Everyone knows this occurs. It's occurred before. Bracket compression is a known phenomenon, except, apparently, for those who work at credit ratings firms. The reason why higher end loans are now requiring a downpayment is that the lenders don't want walkaways, and to prevent walkaways, they need to get the buyer to perceive that the buyer, and not just the lender, is losing money on the house if the buyer walks away.
An insider look at this phenomenon (multimedia).
Sunday, August 19, 2007
Ain't It Cute
May SA: 3.4%
May NSA: 3.2%
June SA: 3.5%
June NSA: 3.8%
July SA: 3.9%
July NSA: 4.2%
California unemployment in July: 5.3%. A year ago it was 4.8%.
North Carolina Unemployment: SA went from 4.6% in Jan to 5.0% in July. NSA went from 5.0% to 5.2%.
Michigan Unemployment: 7.2% in July. 20,000 payroll jobs lost in one month, and 67,000 payroll jobs lost over the last year. Michigan was already in a deep slump by July of last year, but unemployment then was only 6.9%.
PA is an interesting one: Its unemployment rate has dropped substantially over the last year (4.7% > 4.3%), but its total payroll employment has also dropped, moving from 6,006,000 > 5,993,000. So the drop in unemployment was created by a drop in working population of 42,000 over the year (on a seasonally adjusted basis).
Nevada: 4.9% in July SA; was 4.6% in June, was 4.2% a year ago. As for job growth there appears to be weakening trend (unless you're Sebastian):
Arizona. No need really to look past the headline "Arizona’s Unemployment Rate at 3.7 Percent in July as Nonfarm Jobs Decline by 18,800." They have it in red, so I put it in red. I think it's a hint of displeasure at the proceedings. The whole report states that the unemployment rate went up 0.3% from June to July. The full report notes that service industries lost 20,000 jobs and business and professional lost 500 jobs. Arizona is still doing better than a year ago, although the growth rate for employment has slowed very significantly.
Washington State: SA unemployment increased from 4.5% in June to 4.9% in July. Employment growth has slowed since last year, but this rate was still .1% less than July 2006. Construction is still the number 2 growth sector for jobs.
New Jersey announced firmly that the job picture in the state was getting much better, regardless of the fact that unemployment jumped from a steady 4.3% in the last few months to 4.6% in July. One assumes that the unemployed persons disagree with the interpretation. On the other hand, their total employment number is rising whereas PA's is falling, so perhaps one could make a case for that interpretation on a regional basis.
New York published nice NSA numbers, which show that NSA unemployment rose from 4.5% in June to 5.0% in July, although that number was only .1% over last year's 4.9%. Unemployment in NYC has increased to 6.1% from last year's 5.6%. SA went from 4.7% in June to 4.9% in July, with SA NYC increasing from 5.3% to 5.7%.
Georgia does things a little differently. For one thing, it does not screw around with frivolities such as seasonal adjustments. The bottom line is that overall employment grew over the last year but recent trends in initial claims are not that great. GA NSA unemployment in July was 4.9% in comparison to 5.0% last year.
Ohio showed a pattern very similar to PA's. The unemployment rate dropped in July in comparison to June (6.1% > 5.8%), but so did total jobs, which fell by 8,400. Generally this is not a good sign. Over the year, nonfarm payroll employment fell by 1,600. YoY the unemployment rate increased from 5.6% to 5.8%.
Illinois follows a New Jersey like strategy of extolling its superior job gains. Yet the IL SA unemployment rate increased from 5.1% in June to 5.2% in July and SA total jobs dropped 11,500 over the month. In July 2006, the SA UI rate was 4.4%. They do know how to put a positive face on it, however:
July was the 19th consecutive month in which over-the-year job gains exceeded 50,000 new jobs, the longest stretch since July 1999. Illinois has ranked first in the nation in the number of new jobs twice in the last six months (January 2007 with 18,900 new jobs and June 2007 with 11,800). Illinois employers have increased payroll employment by an average of +3,200 new jobs per month since January. Since January 2004, Illinois has added 186,000 jobs, which are more new jobs than any Midwest state.I am sure this is true, but if so it is a reflection of overall weakness in employment trends for the nation and in the region, and I doubt job seekers will be sharing the joy.
Texas (Economagic): SA unemployment rate rose from 4.1% in June to 4.4% in July. Texas' SA rate is still better than last year's 4.9%.
Virginia (Economagic): 3.0% SA, up from 2.9% in June, equal to last year's 3.0%.
The stats for every state in the nation at the BLS. If you select the item to show one month net change, you see that most of the nation is in the 0 - 0.9 range.
States ranked by population at Wikipedia. You will notice that I have covered all of the top 12, amounting to 58% of the entire population of the US. I also added a few. Overall, the picture is of a significant weakening in employment. It is true that the unemployment RATE in some large states is not rising, but when overall payroll employment is dropping, that is not a sign of growth either.
Because of the drop in employment rate (i.e. workforce) in some states, unemployment rates and trends look better than they really are, and when one looks at the data in more detail a recent pattern of weakening is very evident. This is no doubt why the federal government has abruptly decided to enforce the laws against hiring illegal aliens. Last year employment was in a strong growth mode for much of the year. This year the trend is reversing itself.
Coffe Cans And Cognitive Bias
But the thing is, I have met numerous people who are not in the finance business in any way shape or form who did understand what was coming. Over the past year, for example, I have met several business owners who were literally taking proceeds that they would normally deposit and depositing them instead in the classic coffee can buried in the back yard. Their fear was that the instability would result in bank closures and shutdowns, and so the lost interest on the money meant less to them than the security of knowing that they could cover a few months of operational costs in turmoil.
Maybe the reality is that finance types and Stanford undergraduates are weird, and that the rest of us are normal. (Note, I would suggest not the coffee can route but the spreading your money around route.)
Friday, August 17, 2007
The Fed Cut The Bank Discount Rate
Update: And the dollar promptly started to fall. The Fed doesn't want a really strong dollar, because a weaker dollar is helping manufacturing. On the other hand, a stronger dollar is bringing money into the US. The safe haven premium is necessary to some extent because it allows the Fed to fight inflation by cutting interest rates in one way or another without generating an exodus of money. So the Fed is walking a narrow line. End update.
See Oraculations' explanation.
What they did:
The Board approved a 50 basis point reduction in the primary credit rate to 5-3/4 percent, to narrow the spread between the primary credit rate and the Federal Open Market Committee's target federal funds rate to 50 basis points. The Board is also announcing a change to the Reserve Banks' usual practices to allow the provision of term financing for as long as 30 days, renewable by the borrower. These changes will remain in place until the Federal Reserve determines that market liquidity has improved materially. These changes are designed to provide depositories with greater assurance about the cost and availability of funding. The Federal Reserve will continue to accept a broad range of collateral for discount window loans, including home mortgages and related assets. Existing collateral margins will be maintained. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of New York and San Francisco.This change reduces the cost to banks to obtain financing, and ensures that it will be extended. It does not reduce the overnight rate, but recent actions have pushed the effective overnight rate below its target. The plea raised in recent days to get the Fed to accept non-agency MBS appears to have been ignored, but the Fed could quietly change that at any time. The Fed is encouraging banks to use the discount window.
The Fed is trying to prevent the flow of financing to borrowers with good credit from being cut off, thus depressing economic activity a la the 80's. In the last couple of days non-agency loan underwriting has been very restrained. It is not clear whether this Fed action will change that very much, but it will generate a resurgence in the stock market at least in the short term, thus hopefully stopping some of the bleeding.
The real problem for lending going forward is collateral valuation and the resurgence of risk-based underwriting. In practice, this means that lenders want downpayments on many new loans. The day of the 100% stated is pretty much over, and if any are written they will be done in only a few very restricted cases.
In terms of the overall economy, credit lines and home equity loans are often used as credit sources for small businesses, which generate a large hunk of new jobs. No matter what the Fed does, the current situation will have some repressive effect on growth.
The odds are that home prices in bubbly areas (defined as areas in which the median home price/median income ratio has been sharply skewed upward) will start to drop like a rock. Some of them have already been doing so. See Housing Tracker, and note the sudden declines of the last couple of months.
I agree with Tanta's theory that the huge wave of ARM resets will be somewhat countered by modifications of the margins and/or other loan terms wherever it is workable. This could cut expected default rates by 25% or so. Keeping index rates like LIBOR (London Interbank) down will be a battle.
Real mortgage rates are still below the historical average. It is risky loans that are seeing rises in rates, and that is a necessity for restoring the functioning of the market. So the Fed's bias must be toward restraining inflation; rising inflation expectations would boost all rates and produce a much worse situation. Unfortunately, pipeline inflation is still quite high and may even be increasing.
Thursday, August 16, 2007
Wow. Those Asian indexes are tanking for a second night. Earlier things were looking better, but the Tokyo Blues seem to have everyone down. You know, when you start losing 3% one night, and 2-3% the next night, it really adds up. The Nikkei is now 15,600 and a little. Here's hoping they buck up.
I do not see the situation getting better. Too many problems in commercial debt everywhere, a lot of which was apparently used, one way or another, to play with funky mortgages.
Look at that drop. Looks like a Wile E. Coyote trajectory to me:
I Am Reading Fannie Mae's 2006 10K
There is a post up at Calculated Risk about the portfolio characteristics, which they say are current through June 30th, 2007.
Wednesday, August 15, 2007
The havoc among mortgage originating firms has been so severe that it has generated two schools of thought. The first view is that classes of mortgages that are not in peril are being devalued unfairly, and thus that this panic is temporary and will readjust to normalcy within a few months. The second camp is that reality is returning in a vicious sudden attack, and that only the strongest will survive.
[Note that the point of this post is that the bad underwriting has created market conditions in which careful underwriting no longer has the benefit it should carry. There ought to be a much greater return for due diligence, doing old-fashioned things like verifying income and assets, securing real appraisals, and in some cases more than one appraisal, conducting real due diligence on loans bought or originated by delegated underwriting, etc. But there isn't turning out to be that much benefit in the market these days. Consider the case of a good and conservative borrower, who bought a home with an old-fashioned fixed-rate mortgage that is quite affordable to that borrower. But the borrower's neighbors didn't - and now the borrower is sitting on a major loss, because the borrower's neighbors went for those neg-ams, or ARM no-docs, or stated, and are now selling before default. It's a rotten situation to be in. When market risk (especially geographic risk) overwhelms the efforts of good underwriting and careful buying, there is something badly wrong with the entire system. This is why we need a nationwide system of mortgage regulation. Thornburg wasn't a bank, but it performed due diligence and followed strategies that should have prevented it from ever being in this situation.]
I hold generally to the second point of view. Let's take, for example, Thornburg Mortgage. Housing Wire cites an AP story which includes this:
The flight from risky mortgage debt has now spread to loans carrying little actual credit risk. With a $56.4 billion portfolio, Thornburg is the largest mortgage-related security REIT and owns primarily prime loans. But the absence of liquidity for home loans means their market prices have tumbled this year …And Tanta at CR commented:
In my view, outfits like AHM and LUM were accidents looking for a place to happen. Thornburg makes those pretty, competitively-priced, conservatively-underwritten jumbo loans whose rate spread over conforming has tripled over the last few months.Both Tanta and Paul Jackson of Housing Wire are industry insiders. They know their stuff really, really well, and ordinarily I would merely genuflect at their altars and feel thankful for their efforts. Now I must disagree to some extent.
I will concede that the news about Thornburg is shocking, and the reaction genuinely is somewhat overblown. However, this doesn't mean that Thornburg's underwriting and rates won't have to adjust to account for higher risk in the marketplace, and their book value has taken a real loss.
First, Thornburg probably has losses in the loans it has written over the last few months, and it certainly has losses in its holdings (it estimated that its book value dropped from $19.38 to $14.28 during August). Second, it's a REIT, and one of the REIT features is that they must distribute the great bulk of their income each year. This leaves them in a poor position to compete during disruptions, because they don't have the retained earnings to carry them for six months or a year. I am strongly negative upon the use of the REIT structure for this sort of business enterprise, because I believe that being unable to retain more income is a fatal flaw in the mortgage business. To compound the problem, Thornburg doesn't seem to have retained the 10% it could retain. Third, jumbo mortgages do carry higher risk in a situation like this, because the fundamental problem is not "illiquidity", but a discontinuity between home prices and effective incomes of the would-be buyers, plus overbuilding in far too many markets. The situation is not going to improve in the short term. In many markets, any real recovery will arrive after 2010.
The problem with jumbos is that bracket compression dictates that on average, housing priced at the 75th percentile or up is doomed to lose more value than homes priced around the median in a significant downturn. In many markets, these homes can drop 25% to 35% of their value unless a would-be buyer can afford to take a year or two to sell them. Worse yet, there are markets in which a disproportionate number of owners of these homes are involved in either real estate in some capacity (agents, brokers, builders, or financing), and therefore will be disproportionately suffering economically in this downturn. Underwriting on these loans has been exceptionally lax during the run-up of this bubble, and this produce a sharper downturn. Accentuating the normal trend, homebuilders have been concentrating on building these higher-priced homes, so the oversupply and the consequent undercutting of prices on these homes bought in the last few years has been jump-started. (Because builders have been selling at steep discounts, recently built developments are often seeing the sharpest price drops.) And then there are the three D's - divorce, death and disability - which dictate that no matter how good the underwriting, some perfectly stable homebuyers always find themselves having to sell long before their expectation.
Let's take the situation as it stands. Yes, most would-be buyers using jumbos are getting charged higher rates, but the real constriction is most markets is that it is hard to find 100% financing for these homes again, whereas for a few years a buyer with a high credit score would have no problem buying without a downpayment. In states in which the liability for a purchase-money mortgage is generally restricted to foreclosing on the home, right now it is a pretty risky proposition to be handing out 100% mortgages on these things. Even if the borrower continues to be able to pay, the borrower might well choose to walk away to limit his or her loss. (The standard way to do it is to first buy another house, then default on the losing proposition, thus sticking the creditor on the first one with a 20% loss or so). So right now, getting a 10% downpayment is a risk-hedging affair on these homes, but needless to say, it knocks some borrowers out of the market. This, of course, tends to suppress home prices further....
So in this environment, Thornburg's conservatism in writing loans generates less benefit than in a normal environment. I.E., there is far more area risk under current conditions than normal, so the difference between conservatively underwritten loans and laxly underwritten loans yields less in the way of lower defaults and losses than it normally does.
The rate environment continues to eliminate buyers out of the market also. It is axiomatic in the mortgage business that falling mortgage rates lead to housing appreciation, whereas rising mortgage rates dampen appreciation. Bill Poole (yes, Cramer's target), referred to this in his speech of July 20th:
It is important to emphasize that what is odd is not that there was a risk of rising short-term interest rates, as there always is, but that the market clearly expected an increase, as indicated by the shape of the yield curve. This expectation, in turn, was encouraged by the Fed’s Open Market Committee.In other words, don't come crying to Fed, you jerks. We told you, you knew it, and then you acted as if it weren't going to happen. Not expecting losses on portfolios was tantamount to pretending that water was going to suddenly start running up hill, and no one in the business can deny it. See CR on the topic.
Given these widely held expectations of rising interest rates, it is difficult to avoid the judgment that these ARM loans were poorly underwritten at the outset. It was imprudent for mortgage brokers and lenders to approve borrowers who likely could not service the loans when rates rose, and it is surprising to me that sophisticated capital-market investors willingly purchased securities backed by such poorly underwritten mortgages.
Many members of the Fed have produced part of this problem by consistently maintaining that the problem was subprime loans and that the problem would stay with subprime loans. The ratings firms have produced part of this problem, because they have ignored real risk factors such as those I describe here and have rated paper for sale above its proper level. Therefore it is not surprising that investors are now exceptionally leery of anything that is not vanilla all the way. They don't want this Ben 'N Jerry stuff; they want vanilla, because they know the market for vanilla will be there regardless. And vanilla, in this market, is agency-guaranteed.
Sunday, August 12, 2007
Climate Audit Is DOWN
If you go to NASA's Web site and look at the "U.S. surface air temperature" rankings for the lower 48 states, you might notice that something has changed.I've written about McIntyre and Climate Audit before, but the distressing thing is that Climate Audit is down. Has Steyn, that reichwing thug, overwhelmed the site's bandwidth allotment? Or have an army of righteous fanatics launched a denial of service attack to punish treason? In the meantime, the juxtaposition of the Newsweek screed on global warming and Steyn should give anyone with a sense of humor a chuckle to start off Monday morning.
Then again, you might not. They're not issuing any press releases about it. But they have quietly revised their All-Time Hit Parade for U.S. temperatures. The "hottest year on record" is no longer 1998, but 1934. Another alleged swelterer, the year 2001, has now dropped out of the Top 10 altogether, and most of the rest of the 21st century – 2000, 2002, 2003, 2004 – plummeted even lower down the Hot 100. In fact, every supposedly hot year from the Nineties and this decade has had its temperature rating reduced. Four of America's Top 10 hottest years turn out to be from the 1930s, that notorious decade when we all drove around in huge SUVs with the air-conditioning on full-blast.
So why is 1998 no longer America's record-breaker? Because a very diligent fellow named Steve McIntyre of climateaudit.com labored long and hard to prove there was a bug in NASA's handling of the raw data. He then notified the scientists responsible and received an acknowledgment that the mistake was an "oversight" that would be corrected in the next "data refresh."
Recently I had a conversation with a physicist who compared the "climate science" data and integrity problems unearthed recently with the Star Wars brouhaha of the 80s. According to him, at the universities everyone insisted that the missile defense system couldn't work. However, he said it was a remarkable that no one could give an explanation of why it couldn't work, therefore he reserved judgment.
If you think those who have long challenged the mainstream scientific findings about global warming recognize that the game is over, think again. Yes, 19 million people watched the "Live Earth" concerts last month, titans of corporate America are calling for laws mandating greenhouse cuts, "green" magazines fill newsstands, and the film based on Al Gore's best-selling book, "An Inconvenient Truth," won an Oscar.And just what does all that have to do with science? A physicist I know wants to know, and he finds himself unable to follow the logic, and highly perturbed about the "proof". (Not this physicist - the physicist I am talking about doesn't blog.)
Although the figure is less than in earlier polls, 39 percent of those asked say there is "a lot of disagreement among climate scientists" on the basic question of whether the planet is warming; 42 percent say there is a lot of disagreement that human activities are a major cause of global warming. Only 46 percent say the greenhouse effect is being felt today.Newsweek refers to this as the "undermining of science". Oddly, many scientists don't agree, and at least one thinks that scientists are as subject to social pressure as non-scientists. However, here's an encouraging thought: Apparently John Q. Public has a better grasp of the data than the climate scientists.
I'm old enough to remember when the major press outlets were breathless about the impending ice age. My great fear is that I will have to live through two Ice Ages and one runaway Global Warming in my one human life. I feel that this is unfair given everything else I have endured. The blueberries are immune (as scientists are not) to social factors, and they tell me that it is getting colder.
Blueberries or climate scientists, blueberries or climate scientists..... BLUEBERRIES! Every time!
PS: Lubos is an excellent read. I think his post on arctic ice may put him in danger of treason charges among climate scientists, but most non-climate scientists will really enjoy this one. There is even video.
PPS: Lubos on the housing crisis (with a link to a physicist's identification and prediction).
Saturday, August 11, 2007
I'm not convinced that the stock market is going to go south en masse in a drastic way. I do expect a pretty strong redistribution of values. What I am wondering about is these big funds. For one thing, I suspect some have commercial short-term debt tucked away in money market funds, etc. I wouldn't want to be holding it. For another, Lord only knows what the real valuations of some of these ABS (Asset Backed Securities) are
Look, I calculate this stuff all the time, and I'm good at it. But right now I would be hesitate to value paper, because the likely fate of many adjustable mortgages depends on two things:
1) What FNMA does. I can't believe they won't tighten by dumping some of their risk-layered products, and they do have them. If they cut back, the ability to refi is cut back. They have already raised their rates for the riskiest mortgages signficantly, and it is pushing a lot of would-be buyers out of the market temporarily.
2) Where rates go. Average rates as reported by HSH moved to almost exactly where I calculated they needed to be a while ago. I expect some moves to continue. The jumbo mortgages are adjusting upward, but in many areas a rational, risk-based pricing would dictate that. Overall mortgage rates have not yet been impacted by the events of the last few days.
As for defaults, if a person has a non-resetting mortgage and has been paying on it for a few years, that person's risk of of default is not that high, but then you have to adjust for the possibility that a person loses so much money in the home from property devaluation that the person will walk away from it. This is already happening in some markets.
As for loss severity (how much is lost per defaulted mortgage), in this environment average loss severities are doomed to rise for all classes of mortgages, including PRIME CONFORMING pooled on a national basis. We are overbuilt and those who have to sell must cut pricing to move the home in a majority of markets. That fact alone tells me that housing prices will continue to go downward on average even if interest rates don't rise any more. But since loss severities are doomed to increase, in a rational pricing environment interest rates would have to rise somewhat; ergo, interest rates will continue to go up somewhat more.
When you offer rates on mortgages, you know that a certain proportion of them will default. You try to calculate the expected losses (loss severity) from defaults (percentage of defaults), and then compensate for those losses by raising your rate to cover those losses (plus a little) to get the final rates you will offer borrowers. The base rate is dictated by the yield investors are willing to accept. Since investors are nervous, offering rates will have to go up somewhat, because an investor now believes that there is some risk of loss and so must have a higher yield to compensate. Since loss severities will be higher, rates must tend to rise on average.
The one countervailing rate factor is that T-Bill yields are moving lower, but I believe that the heightened risk environment is producing the rise in Treasury pricing (yield is inverse to price). Therefore I would calculate the drop in yields to produce 1/2 - 1/3rd of the normal drop in rates. At this point, additional risk expectations should overwhelm the effect of lower T-Bill yields.
As for stocks:
Howard at Oraculations wrote about the perils of black-box investment models and buying stocks held mostly institutionally. But in general, if you have a good stock with strong management that has not been loading up with debt, I would hold that stock. Even if stock prices go down, over a few years you are likely to make a good gain on the stock, because it probably will grow its business in a difficult environment whereas weaker competitors will lose.
So how do you know the stock is a good one? There is no substitute for reading financials for stocks you buy or hold. None. If you are not willing to do this, you probably will be better off having a professional manage your money, with the proviso that you still must check their logic.
The stock market is a place to invest for long term gains. At any given time, stock prices could be up or down. What matters is not the stock's price today, but the long term performance of the stock. So if you like a company, pay attention to what the company is doing, and see the stock falling because of causes that do not seem intrinsic to its basic business or its management, a period of falling stock prices is the time to buy more. No guts, no glory, but do your homework. This is one reason for selling out before the top - then you have more money to buy later when things go down. Over decades this maximizes your returns.
Risk factors for companies (and thus their stock):
1) High debt in relation to cash flow. Believe it or not, debtors expect to be paid in real money. Real money comes from income or sale of assets. If the company has to sell off pieces of itself to pay down their debt on a more or less consistent basis, they are eroding the fundamental value of their business and thus your stock.
2) Been doing stupid things like buying back their stock with borrowed money while their overall cash flow/profits go south. Sell, sell, sell, almost always.
3) The company doesn't seem to make any actual money from anything but arbitrage. Think Tyco and Enron. Yuck. Bad cash flow plus great capital gains plus high debt is often a sell signal. Like Howard says, if you don't understand it, stay away from it.
4) EPS (earnings per share) goes up, but overall profits/cash flow go down and the company is buying back their stock. For this one, if the company is low-debt and decent cash flow, you can discount it. But otherwise, they are playing dingbat games to get dingbats to buy their stock.
Risk factors should make you spend more time reading a company's financials to figure out what is going on. Then you make your buy/sell/hold decision. Sometimes management is actually making a prudent move and has a decent rationale for what they are doing. Sometimes they explain this in calls, and if it makes sense to you, go with it.
Most people do have some acquaintance somewhere who knows something about the particular business the company is in. Ask your buddies about the basic business environment. Remember - if a company is doing pretty well and has good cash flow and profit when entering or in the middle of a down business cycle, buying it then can make you good returns later. On the other hand, if the company is not doing so well at the top of a business cycle, what do you think is going to happen when the business environment worsens?
Thursday, August 09, 2007
More On BNB Paribas Funds
There are also several highly disturbing facts:
1. These are plain vanilla mutual funds from a highly reputable bank, not some high-roller leveraged hedge fund. Supposedly ho-hum, safe and with daily pricing and redemption privileges. They are designed for the conservative middle-class investing public who are putting money away pour les enfants, or towards a house down-payment.
2. The amounts involved are quite large: as of July 27 the three portfolios together amounted to $2.8 billion.
3. The structured bonds in question are rated AA or better.
The myth of "containment" is now completely and utterly destroyed. If vanilla mutual funds are in such trouble, can you imagine what is happening to the balance sheets of hedge funds? For example, those that bought mezzanine CDO's on margin which now have NO BID? Or, how about those that wrote naked CDS's on those same CDO's?
The ECB (Euro Central Bank, got a currency, need a bank!!) plopped over 100 billion out there to try to prevent worse effects. Bloomberg article. By definition, central banks are the lenders of last resort.
LIBOR is a commonly used ARM index (in different terms), so rising LIBOR rates have a direct effect on US loans, and the effect is not a good one. I watched the BNB Paribas news drive the overseas markets down, which had been rising nicely until then. It also will have a hefty impact on US indexes.
These are not the first overseas funds to be taken out by Asset-Backed Security (ABS) problems, but it's the ongoing nature of the problem which is creating nerves. Everyone is trying to clear, and the effort will slowly drive down commodities and other assets. Basically you have a cash-fueled speculative craze that is slowly unwinding as everyone tries to get to a safe cash-rich position, and these types of moves always do have a net deflationary impact. The goldbugs are not likely to be all that happy for a while.
I have written over and over again in this blog that the problem with commercial paper (CMB and LBO) is worse than that with mortgages, and the unwinding in that will have a far more immediate impact on the economy.
Highly leveraged hedge fund trading (and currency carries) have created the same sort of far-flung chains of lending that prevailed in the late 20's. When a highly leveraged trader gets into trouble, such a trader is forced to sell even under disadvantaged terms. It amounts to a widespread margin call. Now the international situation is quite different than in the 20s right now (all though risk factors are emerging), and central banks will respond differently. I am not predicting a huge depression - but individuals should be aware that clearing debt and maximizing cash is important to prepare for such periods. The ability to borrow always tightens up, and if you can borrow, rates are likely to move higher for almost all borrowers.
Calculated Risk will undoubtedly have excellent discussion. Other blogs I watch for financial perspectives are Mover Mike and Oraculations. They are not financial blogs per se, but both gentlemen have experience in the industry and are independent thinkers. Both already have significant posts up.
I want to stress again that several years of exceedingly lax underwriting standards are what is really causing the ABS problem, and by extension, the overall borrowing prolobem. It was not speculation which caused the 1929 stock price break, but the breakdown of the reporting system on the exchange. This led to an inability to move to rational positions, because no one knew what trading was really occurring.
Just as it was then, no one now can safely model what will happen, because when you start writing a bunch of loans with weak appraisals and don't bother to verify income and/or assets, you have no way to assess risk factors. So once trouble hits, it is extremely difficult to reprice such pools accurately. An overleveraged trading operation facing a margin call can afford to take a one-time loss, but from there it must be able to consolidate and move to rebuild. Because of the lack of correct pricing, such operations are now being forced to sell off more and at worse prices than would be necessary if they could figure pricing correctly, but these very sales will become a self-fulfilling prophecy triggering a race to the bottom
Right now the effect on the US exchanges is being moderated by the weakening dollar, which is creating some oportunities to buy profit- generating operations at a net discount compared to other currencies. This will not persist forever, and the companies which have the best long-term prospects are those that actually do produce a profit. Treasury prices have dropped a bit (raising net yields), so there is an opportunity there for some buyers.
Bank of Korea raised rates overnight. Bank of England was rumored to be planning a rate increase. If the US doesn't match, it will hurt the US dollar even more. The Canadian loonie has been strengthening against the dollar, but I have (perhaps mistakenly) developed an uneasy feeling about it. So much of Canadian trade is conducted with the US that it is hard to conceive that the Canadian economy won't be hurt by the situation.
Wednesday, August 08, 2007
Newsweek Discovers Gunowners
Let's see. The Dems have caved on God, just did a poll discovering that the average American doesn't pick his or her candidates based on gay endorsements, and now it appears they are solemnly contemplating the last problem in Howard Dean's losing trifecta. If only they would get back to "it's the economy, stupid" we might get somewhere.
(Note: it doesn't matter whether you tend left or right - the workings of our political economy is such that both parties must be in the game, or the winning party is free to do absolutely abysmally stupid stuff. And being politicians, they always do, and they generally get paid to do it too.)
Over at Calculated Risk our dedicated duo of truthtellers (SO unfashionable) is taking a look at Fed madness.
Alt-A Reality In CA
BTW, I know my neighbors very well. I live in a culdesac with 6 houses and I refinanced all of them in the last 5 years. 1 full doc, non fixed, 5 alt a. Average value in 2005 was 1,100,000. The house in the court behind me sits on the market for 1 year and currently is listed at 850k. The foreclosure up the street (all same development) got sold as REO at 729k. You tell me, where do I put these people when they adjust?In the short sale line?
The losses on Alt-A in several areas are going to make the subprime losses look like a penny-ante game, and the reason people are having problem with jumbos is because of that. You really need at least 30% down on those right now, and in a few areas, you need 40%.
Tuesday, August 07, 2007
If You Want To Understand
Really, this post is an exceptional resource.
If you are puzzled by current blah-blah about credit markets, Tanta's series on how securitizations work can be found at this post (scroll to the bottom for links to the entire series). The background this gives you will truly enable you to understand the economic problems of the mortgage market.
As The Stone Rolls Down The Hill
--Greater emphasis on regional economic risk. The ResiLogic model will give greater weight to the University Financial Associates (UFA) default multiplier component of the model. The UFA multipliers, which are updated quarterly, raise or lower the ResiLogic expected default probability as a function of a state-level forecast of default risk. This revision affects all mortgage products. Expected default rates will increase on average approximately 20%, depending on the geographic distribution of the mortgaged properties.Tanta at Calculated Risk hasn't stopped hyperventilating about the stupidity of some of the assumptions they were using. According to the statement, Fitch has now decided to use back-end DTI instead of front-end. I went to the ResiLogic page and downloaded the documents. It wasn't clear to me what ratio they had been using, because this is the passage:
--Increased default expectations for short-term and hybrid adjustable-rate mortgage (ARM) products. Expected default rate multipliers for 2/28 ARMs are increased by 22% and by 12% for 3/27 ARMs. Expected default rate multipliers for 5/25 ARMs are raised by less than 5%. Expected default rates for ARMS with adjustment terms below two years are increased by 30%. Option ARMs are subject to an 8% higher multiplier.
--The introduction of a new risk category for borrower income and asset documentation. ResiLogic now categorizes certain loans as 'Low' documentation, in addition to the existing 'Full', 'Reduced' and 'None' categories. Expected default rates for 'Low' documentation loans are 43% greater than for 'Full' documentation loans.
--Default expectations will be determined through analysis of 'back-end' debt-to-income (DTI) ratios, rather than 'front-end' DTI ratios as had been implemented in ResiLogic. If a debt-to-income ratio is not provided for a subprime loan, the default DTI is assumed to be 50%. The impact of this revision is generally minor, although subprime data files lacking in DTI information will be noticeably affected.
--The removal of benefits for short-term loan seasoning. The ResiLogic model reduces default expectations for performing loans as a function of loan age at the time of securitization. This feature of ResiLogic has been removed.
Debt-to-Income Ratios (DTIs): Default rates were slightly correlated to increases in front-end DTIs, as shown in the chart above. A front-end DTI is the ratio of monthly installment debt to monthly gross income (the mortgage payment, taxes, and insurance are included in the back-end DTI). For prime and Alt-A loans, a 5% increase in the DTI yielded roughly a 3% increase in default rates.Lord only knows what they were really using. Normally front end would be mortgage payment to income, and back-end would be total payments to income. Anyone who really believes that FICO scores are more predictive of default than total debt payments/income is an idiot, that's all I can say. Do you really think that someone scheduled to make payments of 70% of their monthly gross income every month is likely to perform long term? Tanta isn't wrong - this reads like amateur hour. Anyway, the original document sounds like they were using all debt except mortgage-related, which can't be true.
For subprime loans, there was slightly less sensitivity to default risk when DTIs rose. A 5% increase in DTI yielded a 2.5% increase in default risk. This lower sensitivity is also reflective of the very high default rates of the subprime sector and the vulnerability of the subprime borrower to external risk factors
However, the fascinating thing is that according to their update, they are still not using a very strong model. They have increased the state-level modelling, but it is not good enough by a long shot.
You can see why the market is twitching so severely - they don't really have an idea of what to expect, and the gatekeepers are blushing and saying "lalala - oops - who'da thunk?"
In other news, Compucredit's second quarter earnings were released last week. They took a net loss of 23 cents a share. Their net interest margin has been bouncing around quite a bit as they try to balance income against defaults:
CompuCredit's net interest margin was 18.9 percent in the second quarter of 2007, as compared to 23.7 percent for the second quarter of 2006 and 17.9 percent in the first quarter of 2007. The adjusted charge-off rate was 9.2 percent in the second quarter of 2007, as compared to 8.3 percent for the second quarter of 2006 and 12.5 percent in the previous quarter. As of June 30, 2007, the 60-plus day delinquency rate was 13.2 percent, as compared to 11.5 percent as of June 30, 2006 and 12.8 percent as of March 31, 2007.Standard & Poors put 207 Alt-A classes on ratings watch negative. It's an even bet as to whether any Fed head will make another statement about "containment" to subprime. Alt-A & subprime originations are considered to have composed about 40% of all originations last year. Rapidly increasing jumbo rates are also going to put pressure on states with higher property values.
I really liked this comment on the post at Calculated Risk by Kirk Spencer as a description of the likely sequence of events leading to the peak of the credit contraction:
I think we're in the first of a three-stage slow motion whammy, and the reason it's slow is it's all tied to real estate and real estate is, at heart, a slow-motion process. (A house doesn't go through several hands a day every day -- usually.)Prime loans in quite a few areas will be facing somewhat higher foreclosures but significantly higher loss severities than normally because of this sequence of events. Of course, residential mortgages are only one aspect of easy credit that is becoming much tighter credit. There is almost no aspect of the credit market that hasn't been affected by loose standards.
Whammy one is the realization that a lot of what's holding up the market has been artificial exuberance. It's been - so far - tied to the loans made to people who couldn't afford it and the speculators. It's beginning to dawn on people that the risk-loans (below AAA bonds) are inflated, and with loss of trust comes loss of money. We're also seeing the barn-door locked with tightening standards which effectively reduces credit, but that's not hitting us yet.
No, that starts to hit us in - I'm guessing - late November or December. That's when we see that peak of resets. And all the people who are looking for refi's -- who probably could have qualified for one of the risky loans a year ago -- can't get their new loans because the risky loans aren't there for them (and they can't qualify). And they start talking foreclosure and jingle-mail.
And that leads us, in about three months (March maybe April next year) to the third and worst whammy. That jingle and foreclosure process is no longer tentative but complete, and suddenly all those banks are carrying properties (expenses) instead of loans (receivables). And they're hoping - anticipating - unloading in the selling season which just started. But nobody's buying. They're not buying for two reasons. First, a lot of people now know there is an excess of inventory. Second, a lot of people who'd like to buy anyway can't because there's no credit -- second whammy magnified. It's around this point that the bank's stated values are insufficient to support the trades they've offered - the REALLY GOOD ones, the ones thought to be AAA.
It's almost nine months out. Smart companies can (and sill) start arranging now to minimize the pain. If enough companies are smart and are willing to take pain to reduce it later, then this will not be much more than the sort of thing we see now. If, however, they all insist on waiting to the last minute... we're screwed.
Caveat -- things like this recent Fitch announcement and the BoA deal in California may accelerate the whole thing, making business attempts to mitigate too little too late, but we'll just have to see.