Commentaries

from Rolfe Winkler:

Lunchtime Links 2-2

Homeownership rate falls to 2000 level (CR) At 67.2% it's still way overstated. Home "ownership" is a misnomer in cases when the owner has withdrawn mortgage equity or when the price of the home has fallen below the principal value of the mortgage. A better measure of homeownership, I think, is just to look at total owner's equity as a % of household real estate. The most recent Fed Flow of Funds report (page 104, line 50) puts the figure at just 37.6%...

U.S. could extend bank fee beyond 10 years, Geithner says (Di Leo/Crittenden, WSJ) The proposed tax on non-deposit liabilities should be permanent, and should target ALL liabilities, including repos. Deposits are guaranteed via FDIC. While that insurance is dramatically underpriced (witness the cash-strapped state of the DIF) at least banks pay something for it. Non-deposit liabilities are also effectively guaranteed, for the biggest banks anyway, via the promise that none which is too big will be allowed to fail. To counter moral hazard, this implicit guarantee must be taxed in order to offset any benefit derived from lower funding costs.

Must-Read: What's a college degree really worth? (Pilon, WSJ) A lot less than you think, as argued here before. This piece is well-written with lots of good data!

AIG derivatives staff said to forgo $20 million in retention bonuses (Katz/Son, Bloomberg) They're still well-paid, but this is better than nothing I suppose.

Deficits as a national security issue -- Sanger NYT & Seib WSJ -- Good to see prominent columnists picking up the thread. A refresher on the Suez Crisis of 1956 offers helpful background.

Rising FHA default rate foreshadows foreclosure crush (ElBoghdady/Keating, WaPo) Key line: "the FHA projects that it will pay out claims to lenders on one out of every four loans made in 2007 -- the worst rate in at least three decades. The claim rate should be nearly the same on the vastly larger volume of loans made in 2008."

Goldman spokesman's most withering rebuttals (Daily Intel) Methinks he doth protest too much...

from Rolfe Winkler:

Lunchtime Links 1-19

MUST READ -- Souring mortgages, weak market put FHA on tightrope (Timiraos, WSJ) Good article, though Timiraos doesn't address the absurd circularity perpetuated by FHA Chief David Stevens when Stevens says, on the one hand, that more gov't lending protects the housing market from further declines, while simultaneously arguing that such lending isn't sustainable. That said, Timiraos has worked lots of interesting stuff into this piece, especially towards the end. For instance, in late '07 investors were refinancing at-risk borrowers into FHA loans in order to shift risk to taxpayers. Barney Frank defends permanently raising FHA maximum loans for certain geographies to $729k. Also lots of data about how badly FHA loans are performing.

Citi's Q4 earnings: Not terrible but not great (Wilchins, Reuters) Trading revenues in the investment bank were much weaker compared to last quarter. Citi also benefited from a tax break, without which they wouldn't have met consensus estimates for the quarter. Here's a helpful chart.

(Click here to enlarge in new window)

How the French outplayed AIG and the Fed (Berman, WSJ...subscription req'd) Great column. Goldman gets all the bad press, but it was far from the only bank that got 100¢ on the dollar for derivative contracts with AIG...

Too big to fail is here to stay (Salmon, Reuters) Felix does a great takedown of Andrew Ross Sorkin's latest column.

Record cash means S&P 500 at half 2007 valuation (Xydias/Nazareth, Bloomberg) A very interesting idea, though lots of bones to pick with the way this piece was written. In nearly 1,300 words the writers never manage to provide a solid definition of how they're computing valuation. What is price to cash flow? Do they mean price to free cash flow? Do they mean price to EBITDA? There's a line about cash flow being earnings plus depreciation and asset writedowns. That may be a very relevant metric. But it's not one that investors know or understand and the authors fail to explain it.

Government weighed down by bad mortgages

The Federal Housing Administration – the U.S. agency that actually enjoys full faith and credit of the government – is in quite a pickle. Reuters reporting that its capital reserves stand at a scant 0.53 percent, below the 2 percent regulatory minimum and without spitting distance of the “help me” threshold.

The deterioration has been fast and furious. Last year the ratio stood at 3% and the year before than 6.4%, according to The Wall Street Journal.

New York Times also has a nice data point:

The F.H.A., which insures loans made by private lenders, guaranteed more than $360 billion in mortgages in the last year, four times the amount in 2007.

The FHA has largely stepped in to fill the vacuum left behind by the banks that had been lending to subprime borrowers. Together with Fannie and Freddie, these housing agencies have kept the housing market from completely seizing up, but there’s a big downside: taxpayers are likely to foot the bill.

The FHA is putting on a brave face, saying reserves should remain above zero, but the still sick state of housing and high unemployment makes such promises sound hollow.

Fannie and Freddie are also feeling the heat. The delinquency rate on Freddie’s single-family mortgages have climbed to 3.33 percent, up from 1.22 percent a year ago. Fannie’s latest tally stood at 4.45 percent, up from 1.57 percent. Though they don’t have the explicit backing of the government – unbelievable but true – they still have a good chunk of the $400 billion equity line they can turn to if the losses accelerate.

from Rolfe Winkler:

FHA bailout watch

From Bloomberg, ht AK:

The Federal Housing Administration, which insures mortgages with low down payments, may require a U.S. bailout because of $54 billion more in losses than it can withstand, a former Fannie Mae executive said.

“It appears destined for a taxpayer bailout in the next 24 to 36 months,” consultant Edward Pinto said in testimony prepared for a House committee hearing in Washington today. Pinto was the chief credit officer from 1987 to 1989 for Fannie Mae, the mortgage-finance company that is now government-run.

Adding to the cost of the government's price floor under housing.

The other GSE problem

It’s hard to keep all the U.S. housing agencies straight. Fannie Mae and Freddie Mac are still basket cases relying on government support, while the Federal Housing Administration and its partner, Ginnie Mae, are setting off alarm bells with their more aggressive efforts to support overstretched homeowners.

But the Federal Home Loan Banks, a government-sponsored enterprise (GSE) that is the lesser-known cousin to Fannie and Freddie, is one to watch — particularly as small regional banks grapple with deteriorating loan portfolios and fewer financing alternatives.

The FHLB is a system of 12 regional banks that provide cheap financing — thanks to the government’s implicit backing — to its 8,100 member banks. Set up during the Depression to support the home real estate market, the FHLB’s primary mission is still firmly rooted in making sure home buyers have access to credit by giving banks the funding they need to extend loans.

Some of the FHLB’s branches, however, made the classic bad investment choice during the credit market boom: They loaded up on subprime mortgages. Unlike Fannie and Freddie, the FHLB wasn’t forced by the subsequent losses into the arms of the government, but they have put a damper on their lending, according to Ben Garber, economist at Moody’s Investors Service.

Citing the Federal Reserve’s flow of funds data, Garber notes that FHLB lending to savings institutions shriveled by $166 billion, to $190 billion for the year ending in the second quarter — a 10-year low and nearly half of what the total was at the end of the first quarter of 2008.

In the big picture, this is positive since it means the much needed deleveraging of the financial system is taking place. But for smaller, regional banks weighed down by commercial real estate loans that are growing more delinquent with each passing day, this kind of number is worrisome, especially as other stop-gap measures begin to disappear.

The Federal Deposit Insurance Corp’s guarantee program, which was set up during the height of the crisis to bolster confidence in qualifying bank debt sold to investors, is scheduled to expire in October.

from Rolfe Winkler:

WSJ: Loan losses spark concern over FHA

A must-read in tomorrow's WSJ talks about the solvency crisis facing FHA:

The Federal Housing Administration, hit by increasing mortgage-related losses, is in danger of seeing its reserves fall below the level demanded by Congress, according to government officials, in a development that could raise concerns about whether the agency needs a taxpayer bailout.

The required reserve level is a paltry 2%. Readers may recall that was the capital level Fannie and Freddie were operating with just before they were taken into conservatorship:

Federal law says the FHA must maintain, after expected losses, reserves equal to at least 2% of the loans insured by the agency. The ratio last year was around 3%, down from 6.4% in 2007.

No doubt the reserve ratio has fallen substantially since last year. The revised figure won't be made available until FHA's fiscal year ends Sept. 30th.

In the past two years, the number of loans insured by the FHA has soared and its market share reached 23% in the second quarter, up from 2.7% in 2006, according to Inside Mortgage Finance. FHA-backed loans outstanding totaled $429 billion in fiscal 2008, a number projected to hit $627 billion this year.

Rising defaults have eaten through the FHA's cash cushion. Some 7.8% of FHA loans at the end of the second quarter were 90 days late or more, or in foreclosure, according to the Mortgage Bankers Association, a figure roughly equal to the national average for all loans. That's up from 5.4% a year ago.

FHA's exploding volumes are just another indicator of the substantial government support propping up house prices.

The subprime to prime mortgage handoff

Data released by the Mortgage Bankers Association confirms the trend that prime borrowers are the ones to worry about.

While the percentage of mortgages entering the foreclosure process in the 2Q held relatively steady at 1.36%, the change in composition is noteworthy.

From the MBA press release:

While the rate of new foreclosures started was essentially unchanged from last quarter’s record high, there was a major drop in foreclosures on subprime ARM loans.  The drop, however, was offset by increases in the foreclosure rates on the other types of loans, with prime fixed-rate loans having the biggest increase. As a sign that mortgage performance is once again being driven by unemployment, prime fixed-rate loans now account for one in three foreclosure starts.  A year ago they accounted for one in five.

Another interesting bit for taxpayers – there’s been a big jump in FHA foreclosures, currently at 1.15% percent. The FHA is essentially a government mortgage insurance agency so foreclosures. While the FHA brags on its website that it’s self-funded, if the losses become too much, it’s safe to assume in the current environment that the government would extend a helping a hand.

Also, it’s the FHA that essentially took on subprime lending last month when it agreed to give mortgages with negative equity in their homes. In July, it loosened its criteria so homeowners significantly underwater could refinance into an FHA loan. These borrowers can now borrow 125% of their home’s worth, up from 105%.

UPDATE: MBA just got back to me about what’s included in their prime category and it looks like Alt-A loans are mostly categorized as prime by those banks participating in the survey. That could be skewing things since Alt-A loans by definition are less than prime and extremely loose lending standards during the boom have made them look more like subprime loans. For example, borrowers taking out an Alt-A loan could state their income rather than prove it.

from Rolfe Winkler:

WSJ: The Next Fannie

A must-read opinion from yesterday's WSJ about the expansion of federal backing for home mortgages:

Only last week, Ginnie [Mae] announced that it issued a monthly record of $43 billion in mortgage-backed securities in June. Ginnie Mae President Joseph Murin sounded almost giddy as he cheered this “phenomenal growth.” Ginnie Mae’s mortgage exposure is expected to top $1 trillion by the end of next year—or far more than double the dollar amount of 2007....

Ginnie’s mission is to bundle, guarantee and then sell mortgages insured by the Federal Housing Administration, which is Uncle Sam’s home mortgage shop. Ginnie’s growth is a by-product of the FHA’s spectacular growth. The FHA now insures $560 billion of mortgages—quadruple the amount in 2006.  Among the FHA, Ginnie, Fannie and Freddie, nearly nine of every 10 new mortgages in America now carry a federal taxpayer guarantee.

The private mortgage lending business has collapsed, especially considering that most large private lenders now operate with a government guarantee.  This is bad news for existing homeowners and banks, who are very much invested in real estate, either directly or as collateral.  Home prices are a function of the credit that's available to finance transactions.  No credit would mean much lower house prices, even from today's "depressed" levels.  This, we're told, is untenable.  If house prices are allowed to fall too far, the financial sector would quickly collapse and the economy would follow.

So the government is propping up prices by providing MORE financing than it did previously, as you can see in the explosion of FHA lending.  Unfortunately, these loans are of poor quality...

The FHA’s standard insurance program today is notoriously lax. It backs low downpayment loans, to buyers who often have below-average to poor credit ratings, and with almost no oversight to protect against fraud.

The piece mentions a report from HUD's Inspector General which noted the FHA doesn't have the resources to handle the explosion in lending, that it's putting the integrity of Ginnie Mae paper at risk.

On June 18, HUD’s Inspector General issued a scathing report on the FHA’s lax insurance practices. It found that the FHA’s default rate has grown to 7%, which is about double the level considered safe and sound for lenders, and that 13% of these loans are delinquent by more than 30 days. The FHA’s reserve fund was found to have fallen in half, to 3% from 6.4% in 2007—meaning it now has a 33 to 1 leverage ratio, which is into Bear Stearns territory. The IG says the FHA may need a “Congressional appropriation intervention to make up the shortfall.”