As the Subprime Turns

As the Subprime Turns [¹]

By John Mauldin | 26 October 2007

As the World Turns is a popular soap opera playing on American TV. It focuses, as do most soaps, on the lives and foibles of its characters, with plenty of dramatic flair. We are watching a different type of soap opera today which we could call "As the Subprime Turns." And the world is watching. It has plenty of drama, lots of flawed characters, a plot that is hard to understand, everyone saying it was the other guys fault and the world (literally) paying for the sins of exuberance in the US.

In this week's letter we look at the housing markets, its affect on consumer spending, take a glance at oil and see if we can figure out why the stock market is so excited.

But first, let me re-visit last week's letter where I talked about the $80 billion Super SIV fund that is being created by Citigroup, Bank of American and JP Morgan Chase. A lot of commentators have been writing about what a bad idea it is, and a few have taken me to task. They think it is a bad idea to rescue bad investments. They want the market to clean out the bad stuff so we can start functioning again. And I agree, but that is not what the fund is going to do, as I understand it. The Super SIV fund is simply offering to buy only the good assets in failed SIVs. In essence, they (and the US Treasury) are worried that there will be a rush to the exits from failing SIVs (mostly in Europe) that will result in a panic forcing down the prices of good assets far below where they should be. That could seriously affect the capital structure of US banks and create a severe credit crunch. This fund simply sets a floor for the price of good assets at $.94 cents in cash and a 4% note. They are not going to take the subprime junk. That is going to have to be written off by whoever owns it. This does not seem like a bail-out to me, but self-interested parties in a free market whose interest is in avoiding a panic and also will allow a mark to market price for assets. I think it makes sense. If I am wrong and any of the toxic subprime assets show up in the Super SIV, then I would agree that it is a very bad idea indeed. Anyone who wants to read my entire take on the SIV problems and missed it last week can go to http://www.2000wave.com/article.asp?id=mwo101907.

"The Market for New Homes is Dead"

Consumer sentiment continued its 17 month decline, dropping in the University of Michigan poll to under 81. And the consumer has a reason to be bummed out. He is watching the price of food and energy rise and home prices fall. [The New York-based Conference Board said Tuesday that its Consumer Confidence Index fell to 95.6 from a revised 99.5 in September. It was the lowest reading since 85.2 in October 2005 when gas and oil prices soared after hurricanes Katrina and Rita pummeled the Gulf Coast. Analysts had expected 99.5.]

Existing home sales fell to an annualized rate of 5 million while the number of homes for sale rose to a 10.5 month supply. Sales are down 19% from a year ago, but much of that drop is in the last few months, as there was an 8% drop in just the last month, as loans (see more below) keep getting harder to find. If you are trying to sell a condominium, it is even worse. There is a 12.6 months supply of condos.

But we also found out yesterday that median prices for homes that sold were down by 5%, y-o-y. It is the first real sign that homeowners were willing to sell for less. Typically home owners don't want to sell for less than the best price they have recently heard for their home. And as they resist lowering their price, the inventory goes up.

And that is the national number. There are markets in Florida where the supply of homes for sale is in the 36 month range. And we are adding more homes every day through foreclosures.

But wait. We find out that new home sales rose by 4.8%. Inventories are down modestly to 8.3 months of supply, but up from the 3.5 months of supply we saw this time last year. Have we seen the bottom? Depends on how you look at the data.

New home sales for September came in at 770,000. Last month they told us August sales were 795,000. So how did they figure an almost 5% rise? Well, it seems they had to revise August sales down by 60,000 as August was really only 735,000. And there is a pattern here. June was revised down by 38,000. July was revised down by 69,000. Cancellations are running at 30%. Anyone care to wager that September numbers won't be revised down below August? And then we will find out that home sales did in fact drop.

If there was such a reckless person, it probably wouldn't be someone from the housing industry. The National Association of Home Builders released their latest survey. This is not a happy group. The index is at its lowest point ever (see chart below). Homebuilder optimism is down. Traffic (people looking to buy a new home) is at its lowest level ever.

As Economy.com says this week,

"The market for new homes is dead for all practical purposes. Eighteen is the lowest rating in the history of the index. The seasonally adjusted numbers are also the lowest on record for October for every subcategory, as they have been for each month since spring began. The bottom of this market will not be reached until there is another significant decline in the cost to prospective buyers, both in house prices and mortgage rates."

Click Here, or on the image, to see a larger, undistorted image.

Why are things so bad? In part, because the home mortgage industry is reeling. It is very difficult to get a non-conforming loan. The subprime mortgage market is comatose, as any mortgage bank which makes a loan today has to expect to keep it on their books. Lending standards are then appropriately tight. There is simply no securitization of subprime loans to speak of, down from $600 billion last year.

And for good reason. As is now known to everyone, investing in subprime asset backed securities had been a bad bet. An index which tracks Residential Mortgage Backed Securities shows that the BBB-index for RMBS is down to $.18 cents on the dollar. And this was for mortgages in a security that was sold earlier this year. Being down 82% in less than a year is not what you expect from an investment grade bond. (www.markit.com)


Click Here, or on the image, to see a larger, undistorted image.

The AAA portion of the same bonds are down by 16% and the AA is down by an astounding 48% with the A rated paper down by 71%. Again, that is for an index of 20 RMBS that was put together and sold this year. Ugly.

Mortgage Pig of the Year

And a great illustration of how really bad it is was written by Allan Sloan (senior editor-at-large for Fortune) in this week's Fortune. It is simply the best explanation of the current meltdown in the subprime market I have read anywhere. I am going to furnish you a brief summary, but you can read it for yourself in the October 29 Fortune, or at this link.

Sloan asked for someone to show him one of the worst of the RMBS. He was directed to one called the Goldman Sachs Alternative Mortgage Products Trust 2006-3 [[remember that name; it will live in infamy: normxxx]]. It was a mere $494 million, or about 1% of the $500 billion RMBS's that were issued last year.

It does qualify for pig of the year. It was composed entirely of second lien loans.

But let's go the story and let Sloan tell it.

"In the spring of 2006, Goldman assembled 8,274 second-mortgage loans originated by Fremont Investment & Loan, Long Beach Mortgage Co., and assorted other players. More than a third of the loans were in California, then a hot market. It was a run-of-the-mill deal, one of the 916 residential mortgage-backed issues totaling $592 billion that were sold last year. "The average equity that the second-mortgage borrowers had in their homes was 0.71%. (No, that's not a misprint— the average loan-to-value of the issue's borrowers was 99.29%.) "It gets even hinkier. Some 58% of the loans were no-documentation or low-documentation. This means that although 98% of the borrowers said they were occupying the homes they were borrowing on— "owner-occupied" loans are considered less risky than loans to speculators— no one knows if that was true. And no one knows whether borrowers' incomes or assets bore any serious relationship to what they told the mortgage lenders. "You can see why borrowers lined up for the loans, even though they carried high interest rates. If you took out one of these second mortgages and a typical 80% first mortgage, you got to buy a house with essentially none of your own money at risk. If house prices rose, you'd have a profit. If house prices fell and you couldn't make your mortgage payments, you'd get to walk away with nothing (or almost nothing) out of pocket. It was go-go finance, very 21st century."

Now as my long time readers know, these securities are sliced up into different portions called a tranche (which Sloan tells me is French for slice, something I didn't know). Goldman created 13 different tranches with ratings from Moody's and Standard and Poor's starting at AAA and going down to (and the last piece or the "equity" tranche is not rated. Six of those tranches have already been completely written off. The AA tranche is now considered junk. Look at the chart below which shows fast the losses started piling up from a start point just 18 months ago.


Click Here, or on the image, to see a larger, undistorted image.

And that average loan to value of 1% is under water with home prices down at least 10% in those California and Florida markets and going lower. But it gets worse. You wonder if the people buying this paper actually read the prospectus on what they were buying. Back to Sloan:

"Through the end of 2005, if you couldn't make your mortgage payments, you could generally get out from under by selling the house at a profit or refinancing it. But in 2006 we hit an inflection point. House prices began stagnating or falling in many markets. Instead of HPA— industry shorthand for house-price appreciation— we had HPD: house-price depreciation. "Interest rates on mortgages stopped falling. Way too late, as usual, regulators and lenders began imposing higher credit standards. If you had borrowed 99%-plus of the purchase price (as the average GSAMP borrower did) and couldn't make your payments, couldn't refinance, and couldn't sell at a profit, it was over. Lights out. "As a second-mortgage holder, GSAMP couldn't foreclose on deadbeats unless the first-mortgage holder also foreclosed. That's because to foreclose on a second mortgage, you have to repay the first mortgage in full, and there was no money set aside to do that. So if a borrower decided to keep on paying the first mortgage but not the second, the holder of the second would get bagged. "Moreover, if the holder of the first mortgage did foreclose, there was likely to be little or nothing left for GSAMP, the second-mortgage holder. Indeed, the monthly reports issued by Deutsche Bank, the issue's trustee, indicate that GSAMP has recovered almost nothing on its foreclosed loans. "By February 2007, Moody's and S&P began downgrading the issue. Both agencies dropped the top-rated tranches all the way to BBB from their original AAA, depressing the securities' market price substantially. In March, less than a year after the issue was sold, GSAMP began defaulting on its obligations. By the end of September, 18% of the loans had defaulted, according to Deutsche Bank. "As a result, the X tranche, both B tranches, and the four bottom M tranches have been wiped out, and M-3 is being chewed up like a frame house with termites. At this point, there's no way to know whether any of the A tranches will ultimately be impaired."

I just touched the surface of this article. It is well worth reading. But it illustrates why no subprime paper is going to be written for some time. There are going to have to be new standards for mortgages that will create the confidence in the probability that an investor will get all the principal and interest due him.

It also means that the weak housing market is going to get worse before we see the bottom. Two million homes will go into foreclosure in the next two years, if home prices continue to slump, said a report released by Joint Economic Committee Chairman Senator Charles Schumer. Home ownership rates are beginning to decline for the first time since 1981.

The ownership rate reached a record 69.3% of households in 2004, up from 64% a decade earlier. With home prices soaring, net household wealth nearly doubled to $51.8 trillion at the end of 2005 from $27.6 trillion in 1995, with real-estate accounting for 47 percent of the change, according to Federal Reserve data.

That growth boosted consumer confidence and spending. Studies show that consumer spending increases by about $5 for every $100 rise in the value of a consumer's home. But if home values decline, the reverse should happen.

When the Going Get Rough, Simply Borrow More

Next week's Outside the Box will be from my friends at Hoisington Investment Management Company. But I have to use one of the tables as it makes a very remarkable point. Most of us (including me) have been under the impression that Home Equity Mortgage Withdrawals have been on the serious decline. But that is not entirely the case as the table below shows.

"First, home equity cash outs, as tabulated by Freddie Mac, totaled $151 billion, or an amount equal to 50% of the rise in total consumer spending (PCE) during the initial two quarters of 2007. Not all of the proceeds of the equity extractions went toward consumer spending, yet the total sum was a substantial source of liquidity for the consumer. More amazing, perhaps, is the fact that over the past 5 1/2 years, $1.1 trillion in equity has been extracted from homes. This represents 46% of the increase in total consumer spending over the same period (Table 2). The tightening of credit standards and declining home prices will virtually guarantee that $1.1 trillion will NOT be extracted in the next few years. Consequently, slower consumer outlay growth can be expected for an extended period."

Click Here, or on the image, to see a larger, undistorted image.

$100 Oil and $1,000 Gold

I wrote in August of 2006 that $100 oil would be the solution and not the problem. It will cause people to look for substitute energy sources. However, I did not think we would see $100 oil so soon. I was asking in January of this year, with oil bouncing around the mid-50's (down from a recent $77) whether oil should be $40 or $80? Today, oil hit $92 before selling off a little at the close to $91.86.

Let's go back to the beginning of 2002. Oil was $15.89 a barrel and 17.96 (in euros). Oil has since risen 3.5 times in terms of euros and 5.8 in dollar terms in less than 6 years. The difference clearly shows the depreciation of the dollar.

It is hard to imagine that $90 oil is not going to have some impact on consumers. If you heat your home with oil, and tens of millions do, you are going to be wearing more sweaters in the house or you are going to have a much higher bill this winter.

Between rising costs and a decreasing ability to borrow, the US consumer is finally going to have to retreat a little in the next few quarters.

Gold closed today at $787.50 with the dollar falling to almost $1.44 in euros. That is an interesting cap to the week in which I was at the New Orleans Conference attended mainly by gold bugs. 80% of the exhibitors were natural resource companies of one flavor or another.

As you might imagine, there were a lot of happy investors. And a lot of advisors bearish on the dollar, as I have been for almost six years. But I have to tell you that makes me nervous.

One of my favorite movies of all time is Trading Places. It is Dan Akroyd and Eddie Murphy at their best. But one of the great lines comes from Don Ameche and Ralph Bellamy, who play the two older brothers Randolph and Mortimer Duke, respectively. As the world of orange juice prices go against them, Don Ameche turns to Bellamy and yells, "Sell! Mortimer. Sell!" But there was no one on the other side to buy, and they went bankrupt.

And who can forget the cameo scene in Murphy's Coming to America where he gave a sack of cash to two skid row bums, who turn out to be the Dukes. They leap up shouting "We're back in business!" Such is the mentality of traders.

I think $1.50 against the euro is in the cards. But the dollar could bounce back viciously before that, as everyone everywhere is bearish. There needs to be someone on the other side of the trade. One of the great rules of trading is that when everybody is on the same side of the investing boat, the boat is going to turn over.

That being said, I think there is still time to get in on the fun in gold. In my opinion, gold is a neutral currency. I think gold goes up against most currencies everywhere over the next five years. You can play that with an ETF on gold or by buying gold stocks. I like the stock approach.

I spent some time in New Orleans with old friends Doug Casey and David Galland of Casey Research. They do a lot of research on gold and natural resource stocks and have been on a roll of late. If you want to invest in gold stocks, you should seriously consider subscribing to Doug Casey's International Speculator. I made my first "ten-bagger" almost 25 years ago on a tip from Doug (where does the time go?). He is still on his game, although with somewhat less hair. But it is ok to lose some hair as long as you do not lose the passion.

Normxxx    
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The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.

The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

Whoever Moves Loses

Economic Zugzwang: Whoever Moves Loses

By Mike Shedlock / Mish | 30 October 2007

Curve Watcher's Anonymous is once again eying the yield curve and mortgage rates following yet another set of horrible existing home sales and news home sales numbers.

Yield Curve As Of 2007-10-24

click on chart for a sharper image

There has been a strong rally in treasuries (lower yields) in conjunction with consistently weak economic data. However, in spite of a 100 basis point (1%) cut in the discount rate, and a 50 basis point (.5%) cut in the Fed Fund's Rate as compared to a year ago, Curve Watchers are noting that 30 year mortgage rates are almost exactly where they were a year ago, and 1 year ARM rates are substantially higher than a year ago. 15 year fixed rates are lower than a year ago, but only by a mere 11 basis points.

The picture is even worse than it looks however, because the above rates are for prime borrowers with a reasonable down payment. Subprime borrowers are facing resets substantially higher. Someone struggling to make a home payment at a teaser rate of 3% is going to be in serious trouble at 9%.

So the idea that these rate cuts are going to do anything to help borrowers in trouble is seriously misguided. However, that is not stopping Bernanke from trying. Certainly the market is now expecting the Fed to cut rates. With that in mind, Curve Watcher's Anonymous is noting a striking similarity between recent yield curve action and that in 2001. Let's take a look.

Yield Curve 1999 - 2007

click on chart for a sharper image

In the above chart

$TYX is the yield on the 30 year long bond.
$TNX is the yield on the 10 year treasury note.
$TYX is the yield on the 5 year treasury note.
$IRX is the discount on the 3 month treasury bill.

Take a good look at the above chart. Haven't we seen this series of plays before?

There's only three small problems. The last time the Fed embarked on a slash and burn campaign lowering interest rates, the U.S. dollar index was sitting near 120, gold was near $300, and oil was near $20. Now the dollar index is well under 80, gold is close to $800, and oil is over $90.

The second problem is the Fed created a housing bubble (and lots of jobs) the last time they tried slashing interest rates. Who needs a house now that does not already have one (or two or three)? Should the Fed dramatically lower rates again, where are the jobs going to come from? [[Can you push a wet noodle uphill?: normxxx]]

The third problem is that drug ([[artificially low rates: normxxx]]) induced highs need stronger and stronger doses to maintain the same high. There is not much room below interest rates of 1 to even think about a higher high [[besides, we stopped at 1% last time, because any lower and all of the MM Funds would have gone BK: normxxx]].

High energy prices and falling home prices are two things of concern to consumers. The irony of the situation is that the only way oil prices are likely to sink is if the U.S. heads into a recession and/or the dollar strengthens considerably.

The Irony of Bernanke's Predicament

Bernanke is acting to prevent said recession by cutting rates. Good luck with home heating season coming up. If Bernanke does not cut rates, it will hasten the recession. A recession is badly needed I might add, but Bernanke does not see it that way.

In addition, the U.S. Dollar is likely to rally if the Fed pauses because rate cuts are priced in. Given that the dollar and the stock market have been inversely correlated for quite some time, if Bernanke acts to shore up the dollar by failing to cut rates, the stock market is likely to take a big hit.

There are no winning moves. But— Bernanke, it's your move.


Normxxx    
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The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.

The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

Minyanville's daily Five Things 25 October 2007

Minyanville's daily Five Things You Need to Know to stay ahead of the pack on Wall Street
Click here for a link to complete article:

Five Things You Need to Know: Durable Goods; New Home Sales; Price Capitulation?; Those "Subprime" People; Home Energy Conservation Tips

By Kevin Depew | 25 October 2007

1. Durable Goods

As expected, orders for durable goods unexpectedly fell in September, the Census Bureau reported. Let's look inside the numbers.

• New orders for durable goods fell 1.7% in September.


• Wait, what exactly are "durable goods"?


• The Commerce Department defines "durable goods" as goods designed to last three years or more.


• Why three years? Because that's the number. Seriously. They had to pick a number to distinguish them from non-durable goods and the decision was made to use three.


• For an eye-opener, take a look sometime at this breakdown of the composition of industry categories.


• Anyway, back to today's release. Although we care about the headline in durable goods orders— in this case down 1.7%— what we really want to pay attention to is "capex."


• What is "capex"? It's economic jargon for "capital expenditures."


• Capital expenditures are business spending that creates (hopefully) future benefits. It's important because "capex" is one of the few "forward looking" datapoints in all of economics.


• Almost by definition, most economic data reports what has already happened.


• Capital expenditures, on the other hand, can give us some idea of business sentiment— companies that are fearful of coming economic conditions try to hold back spending.


• Core nondefense capital goods orders (excluding aircraft and shipments), a proxy for capex, were 0.4% higher, led by a 4.3% rise in machinery orders [[that's especially important: normxxx]].


• Capex shipments rose 1%.


• So while the headline looks pretty bad, internally the report is more of a mixed bag with enough fodder for bulls and bears alike.

2. New Home Sales

Sales of new homes in the U.S. were able to show a dramatic and unexpected rise in September thanks to the miracle of downward revisions to the August data.

The pace of new home sales rose 4.8% in September to an annualized 770,000 units.
How did that happen?

• Simple, 60,000 homes thought sold in the previous months' data turned out to be NOT sold.


• Year-over-year sales are down 23.3%


• The average price fell 3% to $288,000 [[but there is a big lag y-o-y; prices are down as much as 18% since March!: normxxx]].


• Barry Ritholtz has a comprehensive take on the data over on his Big Picture blog.


• We've discussed the cancellation rates at homebuilders here before.


• For the quarter the cancellation rates run from 35% at Centex (CTX), to a whopping 68% at Beazer (BZH) and 50% at KB Homes (KBH).

3. Price Capitulation?

Speaking of home sales, let's take one more look at yesterday's existing home sales data.

• We were discussing this last night with Minyanville Professor Adam Warner who noted that in his area "nothing is really selling, but prices aren't moving either."


• I found the same thing to be the case in Lexington, KY last weekend, and a number of Realtor friends reported taking other jobs or returning to prior careers because the market is "stagnant."


• But that anecdotal evidence isn't what is happening on the national scene.


• While the real estate mantra "all real estate is local" sure sounds good, the reality is that this time around all real estate is global.


• Why would that be the case? Because the weakest links are acting as a canary in the coal mine of sorts and warning of things to come nationally.


• For example, one thing we wanted to clarify from yesterday's existing home sales report is the worrisome decline in prices even as inventory continues to build.


• The supply of existing homes hit a record 10.5 months.


• Meanwhile, the median price of existing homes fell 5.7% for the month.


• Is this the first sign of price capitulation in the face of inventory builds?


• Possibly. But what is most worrisome for the future is that inventory bulged in the face of the price declines.

4. Those "Subprime" People

Almost a week ago David Einhorn, founder of Greenlight Capital, gave a speech at the 17th annual Graham & Dodd Breakfast at the Hellbrun Center for Graham & Dodd Investing. This paragraph from his speech, which is well worth a read, stood out:

"In my view, the credit issues aren't just about subprime. Subprime is what the media says. Subprime is what parts of the financial establishment say. Subprime is about them— 'those people' and the people who made foolish loans to them. The word 'Subprime' is pejorative."

Indeed. Subprime is being passed off as the disease, when in reality it's merely a symptom [[lets all of those predatory realtors, brokers, and banks— who skimmed $billions— off the hook, anyway: normxxx]].

5. Minyanville Presents: Home Energy Conservation Tips

This morning we woke up in New York City to what may be our first, official Autumn day. With that in mind, and considering that Americans are expected to spend more than $160 billion this year to heat their homes, we present: Minyanville's Home Energy Conservation Tips.

While our homes are more efficient today than they were 30 years ago, considerable opportunity remains for greater home energy efficiency and the associated benefits. To help households across the country reduce their home energy bills, Minyanville has prepared the following guidelines:

• A large percentage of heating and cooling efficiency is lost through doors and windows. Board up your home’s windows with plywood and seal all doors to prevent energy seepage [[the administration recommends duct tape: normxxx]].


• Did you know that a fireplace can shave as much as 10% off your winter heating bill? But wood is expensive. Save on wood costs by burning plastic [[credit cards are especiually to be recommended: normxxx]].


• Scientists say heat rises. During cold winter months try to sleep on the ceiling [[or, maybe the roof?: normxxx]].


• Instead of costly and dangerous space heaters at night, consider creating a Personalized Nightlight & Bonfire by smoking in bed [[don't forget to turn off your smoke detector, or it is liable to wake you— and it's hard to sleep with all that racket: normxxx]].


• The human body is a very efficient heating and cooling system. Instead of central air conditioning and heating, just get a bunch of warm bodies[!?!]


• Take a cue from nature and gain 200 lbs of insulating, warming fat for the winter. (Later, portions of this fat can be used to create candles and heating oil.)


• Window unit air conditioners are very inefficient because they blow out hot exhaust when in use. During the cold winter months, turn your air conditioner around backwards so the hot air blows in, not out.


• Move your family somewhere warm in the winter, cold in the summer, just right during the fall and spring. Become a meteorologist to help plan the moves. Charter a private jet to avoid long airport delays [[I'm sure Al Gore can give you some tips: normxxx]]


• Be alert for anything burnable that your neighbors may leave unattended [[preferrably not nailed down: normxxx]].


• Be conscious of where you set your thermostat. Because the body’s normal temperature is 98.6 degrees it is best to set your home’s thermostat to 98.6 degrees for consistency.


• It takes much less energy to heat a car than it does to heat a house. To save on home heating costs, sleep in your car in the garage with the engine running.


• Carry the warmth of anger, humiliation, slights and regret with you at all times by storing them in a Little Box of Hurt you keep in the pit of your stomach [[over the next few years, you may get your money's worth from Wall Street, the Humungous Big Bankers and Brokers, etc.: normxxx]].

  M O R E. . .

Normxxx    
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The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.

The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

Housing— The Worst Is Yet To Come

Housing— The Worst Is Yet To Come

By Mike Shedlock / Mish | 30 October 2007

The housing industry plunged deeper into recession as existing home sales plunge 8 percent.

There is no rational basis for anyone to suggest the worst is right here right now. But that does not stop anyone from trying (and they have been trying for months on end).

Once again the NAR is putting lipstick on a pig with their report Mortgage Availability Improving But Hampered September Existing-Home Sales.

Temporary problems in the mortgage market are easing and are expected to free some pent-up demand, but disrupted existing-home sales and distorted prices on sales closed in September, according to the National Association of Realtors®. Even so, prices rose in the Northeast and Midwest.

My Comment: Pent up demand? The only thing there is pent up demand for is selling. People are so far under water they are praying to sell at a higher price to avoid foreclosure.

The third quarter finished better than expected, with a 5.42 million annual rate of existing-home sales versus the 5.38 million forecast by NAR.

My comment: If you set the bar low enough, eventually you can stumble over it.

Lawrence Yun, NAR senior economist, said the decline is understandable. "Mortgage problems were peaking back in August when many of the September closings were being negotiated, and that slowed sales notably in higher priced areas that rely more on jumbo loans," he said.

My comment: Once again there is no rational measure or reason for suggesting that mortgage problems peaked in August.

"It appears raw inventories are stabilizing, but the housing supply is a bit inflated now because the sales pace does not reflect underlying market conditions— sales were dampened by the mortgage cancellations," Yun explained.

My comment: The inventory supply is now 10.5 months up from 9.6 months in August. Is this stabilization? One of the reasons raw numbers appear to be holding is people are pulling listings off the market praying for better prices. Many people who want to sell cannot sell because they are too far under water. These people represent pent up selling demand not pent up buying demand.

“Once the pent-up demand begins to move, we’ll see housing supplies begin to ease and then prices will edge up.”

My comment: What year is that? We have upcoming issues with mortgage resets as the following chart shows [[as far as the eye can see, or at least until past 2012...: normxxx]]

Subprime resets peak this year but Alt-A problems which are just as big do not peak until 2011. In addition, the overall economy is slowing dramatically. There is going to be a consumer led recession to deal with [[so there go the As and some of the AAs: normxxx]]. Unemployment has bottomed this cycle and is bound to rise dramatically. That will further pressure housing prices in a very significant way. The worst (by a long shot) is yet to come. Remind me to start looking for a true bottom in 2011-2112. Perhaps we get a bounce somewhere along the way.

Normxxx    
______________

The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.

The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

The Most Troubling Chart

The Most Troubling Chart In The Market Right Now


By Brian Hunt | 30 October 2007

The stock market's opinion of the U.S. consumer is clear: He's sick as a dog.

We typically don't pay much attention to the "consumer is dead" crowd. Bears have been calling for the demise of the American spender for decades, and he's proven more resilient than a cockroach. But one look at the list of stocks scraping new 52-lows reveals a shocking trend… America's premier "consumer" stocks are tanking.

A few of the biggest losers here: Cabela's (outdoor gear), JCPenny (department stores), Nordstrom (high-end retail), Stein Mart (department stores), La-Z-Boy (furniture), Pool Corporation (pools), P.F. Chang's (restaurants), Brunswick (recreational boats), and Liz Claiborne (clothing)… all setting new 2007 lows.

And perhaps the most troubling loser? We present the nation's largest home improvement chain, Home Depot. The Depot lives and dies by America's propensity to spend spare cash on roofing, room additions, and lawn work. Second-quarter sales declined 1.8%... and the stock is down 21% this year. No, the consumer isn't dead, but his free-spending days are behind him.


Click Here, or on the image, to see a larger, undistorted image.


Normxxx    
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The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.

The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

Crumbling Credit; Deadly Leverage

When Crumbling Credit Meets Deadly Leverage

By Richard Benson | 30 October 2007

If our country's debt problems in the private sector were simply limited to the $1.5 trillion of subprime mortgages that needed to be repaid, restructured or foreclosed, the situation might be manageable. But they're not, and it isn't. It's widely understood now that this mess was caused by a Federal Reserve that pumped up home ownership (for everyone in America) and then proceeded to cut interest rates too low for too long, and by credit market participants who threw common sense and basic loan underwriting to the wind. In looking back at this era of easy lending, the orgy was effectively facilitated by Wall Street's ability to irresponsibly underwrite loans and then look the other way. Risky mortgage securities were packaged and sold in the secondary market to suckers who bought into the theory that the housing market would only go up [[and who foolishly believed the rating agencies: normxxx]].

As equity extraction becomes a thing of the past, a recession seems inevitable. I predict there will be continued credit surprises mostly on the downside as employment weakens, jobs are lost, and bills go unpaid. As a consumer-led recession unfolds, personal income and corporate revenues won't cover many debts, and the game of always being able to refinance has ended. So, for many borrowers the game is already over; they just don't know it yet.

The credit cycle has clearly turned. Financial institutions, such as banks, have only begun to add to the massive loan loss reserves they'll need to shelter from the storm of at least $2 trillion of consumer, commercial real estate, corporate, and single family mortgage loans, that could easily roll over into default. And that's not all. Loan loss reserves are also being set aside as banks brace for the stress that has begun to appear in commercial mortgages and mortgage securities. See the chart below:


Click Here, or on the image, to see a larger, undistorted image.

In the world of easy money and the exponential increase of artificial liquidity and credit, there is also the "shadow world" of derivatives.

A derivative allows a market participant to make money or hedge a position as if they owned a financial instrument, yet they're not required to put the asset on-balance sheet (or post the capital the same way they would have to if the asset were on-balance sheet).

Why is this important? As Hank Paulson, Secretary of the Treasury, runs around trying to bail out the Structured Investment Vehicles ("SIVs"), it's become pretty obvious. These SIVs provided a way for huge banks, like Citibank, to hold another $400 billion of assets but conveniently keep them off-balance sheet. Up until a few weeks ago, the financial press hadn't even heard of a SIV. Now, suddenly, they're threatening the core of the financial system because the loans might have to go back on-balance sheet and tie up precious equity capital!

The big players love derivatives because they allow massive off-balance sheet leverage. However, the hedge funds and mortgage companies that have all blown up recently (along with some Wall Street firms and Bear Stearns) have learned a hard lesson: mixing massive credit losses with high leverage is a formula for quick and definitive financial death. While leverage may be positive to the bottom line on the upside, it can quickly kill on the downside.

While SIVs are continuing to rock the system, they are a mere rounding error compared to Credit Default Swaps ("CDSs") and other major derivatives. (CDSs are the most widely traded credit product.) See the Table below:

$28 trillion of CDSs is a staggering number! It's more than double the U.S. GDP, and is more than four times the total of all outstanding corporate debt. The off-balance sheet "shadow world" of credit actually dwarfs the on-balance sheet visible world.

As the Music Man says, "There is a lot of gamboling going on here in River City"

In real speak this means the financial players reap all of the benefits on the upside, while the investors assume most of the risk on the downside. The "gamboling" going on is off-balance sheet and, therefore, hidden from the investor's view.

In July and August we all learned how cruel the markets can be. When the market value (gain to one party, and loss to the other) of mortgages and mortgage derivatives spiked in value very quickly, quite a number of firms, and funds, simply failed. It was very sudden. Derivatives are by design extraordinarily leveraged, so tiny changes in the financial markets can affect their value in a big way. A sizable wave in the financial markets can easily be magnified and turned into a tsunami of market losses. With the current level of credit derivatives all sitting off-balance sheet (and unnoticed like the SIV's recently were), unsuspecting investors could wake up to discover more alarming losses amounting to a few trillion dollars that were neither anticipated nor welcome.

Finally, the financial institutions that have exposure to on-balance sheet credit risk are the Who's Who of major hedge funds, major banks, and Wall Street investment banks. Guess who the major counterparties are in the derivatives market? Why, they're the same major players [[and, remember, for every winner on a derivatives trade THERE MUST BE A LOSER! : normxxx]]! So, while Bear Stearns has become the poster boy for all that's wrong with subprime mortgages, don't worry. Other firms like JP Morgan Chase, Morgan Stanley, Citibank, Merrill Lynch, and even Goldman Sachs, may have their pictures posted alongside Bear Stearns' in the "Hall of Shame" when corporate credits turn down. Crumbling credit combined with deadly leverage can prove fatal to portfolios invested in financial stocks.

Normxxx    
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The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.

The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

'Level 3' Decimation?

The Bear’s Lair: Level 3 Decimation? [¹]
Click here for a link to complete article:

By Martin Hutchinson | 29 October 2007

There’s a mystery on Wall Street. Merrill Lynch last week wrote off $8.4 billion in its subprime mortgage business, a figure revised up from $4.9 billion, yet Goldman Sachs reported an excellent quarter and didn’t feel the need for any write-offs. The real secret of the difference is likely to be in the details of their accounting, and in particular in the murky world, shortly to be revealed, of their "Level 3" asset portfolios.

Both Merrill and Goldman have Harvard chairmen— Merrill’s Stan O’Neal from Harvard Business School and Goldman’s Lloyd Blankfein from Harvard College and Harvard Law School. Thus it’s pretty unlikely their approaches to business are significantly different— or is a Harvard MBA really worth minus $8.4 billion compared with a law degree? (The special case of George W. Bush may be disregarded in answering that question!)

We may be about to find out. From November 15, we will have a new tool for figuring out how much toxic waste is in investment banks’ balance sheets. The new accounting rule SFAS157 requires banks to divide their tradable assets into three "levels" according to how easy it is to get a market price for them. Level 1 assets have quoted prices in active markets. At the other extreme Level 3 assets have only unobservable inputs to measure value and are thus valued by reference to the banks’ own models [[i.e., the banks' 'best guess': normxxx]].

Goldman Sachs has disclosed its Level 3 assets, two quarters before it would be compelled to do so in the period ending February 29, 2008. Their total was $72 billion, which at first sight looks reasonable because it is only 8% of total assets. However the problem becomes more serious when you realize that $72 billion is twice Goldman’s capital of $36 billion. In an extreme situation therefore, Goldman’s entire existence rests on the value of its Level 3 assets.

The same presumably applies to other major investment banks— since they employ traders and risk managers with similar educations, operating in a similar culture, they probably have Level 3 assets of around twice capital. The former commercial banks Citigroup, J.P. Morgan Chase and Bank of America may have less since their culture is different; before 1999 those institutions were pure commercial banks and a substantial part of their business still lies in retail commercial banking, an area in which the investment banks are not represented and Level 3 assets are scarce.

There has been no rush to disclose Level 3 assets in advance of the first quarter in which it becomes compulsory, probably that ending in February or March 2008. Figures that have been disclosed show Lehman with $22 billion in Level 3 assets, 100% of capital, Bear Stearns with $20 billion, 155% of capital and J.P. Morgan Chase with about $60 billion, 50% of capital. However those figures are almost certainly low; the border between Level 2 and Level 3 is a fuzzy one and it is unquestionably in the interest of banks to classify as many of their assets as possible as Level 2, where analysts won’t worry about them, rather than Level 3, where analyst concern is likely.

The reason analysts should worry is that not only are Level 3 assets subject to eccentric valuation by the institution holding them, but the ability to write up their value in good times and get paid bonuses based on their capital uplift brings a temptation that few on Wall Street appear capable of resisting. Both Goldman Sachs and Merrill Lynch are reported to have made profits of more than $1 billion on their holdings of Level 3 assets in the first half of 2007, for example, profits on which bonuses will no doubt be paid at the end of their fiscal years. Given that we have had five good years on Wall Street, years in which nobody has known the amount of Level 3 assets on banks’ balance sheets, and no significant media waves have been made questioning their valuation methodologies, it would not be surprising if many banks’ Level 3 assets had become seriously overstated, even without any downturn having occurred.

When Nomura Securities sold its mortgage portfolio and exited the US mortgage business in this quarter, it took a write-off of 28% of the portfolio’s value, slightly above the 27% of the portfolio that was represented by subprime mortgage assets. Were Goldman Sachs’s Level 3 assets similarly value-impaired, it would result in a $20 billion write-off, more than half Goldman’s capital, leaving the bank severely damaged albeit probably still in existence.

Defenders of Goldman Sachs and the rest of Wall Street will insist that less than 27% of their Level 3 assets are represented by subprime mortgages yet that is hardly the point. Subprime mortgages, estimated to cause losses of $400-500 billion to the market as a whole, though only a fraction of that to Wall Street, have been only the first of the Level 3 asset disasters to surface. There is huge potential for further losses among assets whose value has never been solidly based. These would include the following:

• Mortgages other than subprime mortgages. With the decline in house prices accelerating, the assumptions on which even prime mortgages were made are being exposed as fallacious. As house prices decline, debt to equity ratios increase, and for mortgages with an original loan-to-value ratio of 90% or more quickly pass the 100% at which a mortgage becomes uncovered. If the value of conventional mortgages decline, many securities related to them, currently classed as Level 1 or 2 assets, will become un-marketable and descend into Level 3


• Securitized credit card obligations. $915 billion of credit card debt is currently outstanding, the majority of it securitized, and its default rate is likely to soar as the full effects of the home mortgage market’s crack-up spread to the credit card area. The risks in Level 3 portfolios derived from this asset class arise particularly in the areas of complex derivatives and manufactured assets based on credit card debt pools.


• Leveraged buyout bridge loans. After the hiccup in August, the market in these has reopened recently, although around $250 billion of them still remains on banks’ balance sheets. The value of a leveraged buyout bridge loan that has failed to find a pier to support the other end of the bridge is very dubious indeed, even though these loans are being carried in the books at or close to par. As the value of underlying assets declines and the cash flow fails to match debt payments, the deterioration in credit quality of these loans will accelerate.


• Asset backed commercial paper. The amount of [other than mortgage] asset backed commercial paper outstanding has dropped from $1.2 trillion to $900 billion in the last three months. This financing structure was always unsound; it was basically a means of removing the assets backing the commercial paper from bank balance sheets, and always faced the problem of a severe mismatch between asset and liability duration. The $100 billion vehicle intended to rescue this market has found a mixed reception to say the least. It is likely that as credit conditions deteriorate, the assets underlying ABCP vehicles will increasingly find themselves on bank balance sheets, where they will prove to be almost completely unmarketable.


• Complex derivatives contracts. Even simple interest rate swaps and currency swaps caused large losses in the last significant credit tightening in 1994, although most of those losses were suffered by Wall Street’s customers rather than Wall Street itself. The more complex transactions that have been devised during the last twelve giddy years are much more likely to prove impossible either to sell or to hedge. Goldman Sachs reported that in the third quarter of 2007 its profits on derivatives used for hedging more or less matched its losses on subprime mortgages. It is likely in reality that the bulk of those profits were incurred through model-based write-ups of value on contracts that were within the Level 3 category— after all, Goldman’s Level 3 assets increased by a third during the quarter. It’s not much good shorting to match a long position you don’t like if your hedging shorts prove to be impossible to close out.


• Credit Default Swaps, the global outstanding value of which in June 2007 was $2.4 trillion, according to the Bank for International Settlements. These are a relatively new instrument, the efficacy of which has not been tested in a downturn. It appears likely that the value in banks’ books of their Level 3 credit derivatives contracts bears no relation whatever to reality. As discussed above, the incentives have been all in favor of inflating it.

The capital underlying Wall Street, at the top, is not all that large— a matter of a few hundred billion. Given the piling of risk upon risk that has been engaged in over the last few years, and the size of the losses in the mortgage market alone that seem probable— my own estimate last spring of $980 billion looks increasingly likely to be somewhat below the final figure— it appears almost inevitable that in a bear market in which liquidity dries up and investors become skeptical, Wall Street’s capital will be wiped out. Only the commercial banks like Wachovia and Bank of America whose investment banking ambitions have been largely thwarted and portfolios of Level 3 rubbish are correspondingly lower are less likely to disappear.

Given the size of the overall figures involved and the excessive earnings that Wall Street’s participants have enjoyed over the last decade, a taxpayer-funded bailout of Wall Street’s titans would seem politically impossible, however loud the lobbyists scream for it [[but don't bet on that— it's happened in the past "for the good of the country": normxxx]].

In the long run, that is probably a blessing for the US and world economies.

______________

The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.

The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

Twenty One Flavors of Mortgage Fraud

Twenty One Flavors of Mortgage Fraud [¹]

By Howard Lax for iTulip.com | 29 October 2007

Mortgage fraud is now a part of our lexicon, but few people understand what this means and the harm it causes. Mortgage fraud is a catch all phrase that encompasses schemes allowing one or more parties to a real estate transaction to obtain money through illegal or unethical means. Mortgage fraud cost us, as a society, somewhere between $946 million and $4.2 billion in 2006, and the cost will increase. Residential mortgage transactions are particularly susceptible to fraud, since the mortgage lending industry relies on patterned transactions to simplify home sales and mortgage financing with as little cost and time as possible.

In a "normal" residential sale transaction, the buyer, seller, and real estate broker(s) negotiate a sale using a model purchase agreement. The buyer meets with a loan officer from a mortgage broker or lender, and chooses a standard loan product to finance the transaction. The lender obtains an appraisal of the property and a credit report for the borrower. An investor underwrites the loan with the assistance of an automated system, conditionally commits to purchase the loan after closing, and "locks" the loan terms. The mortgage broker or lender obtains a title insurance commitment and schedules the closing after the loan is approved. A closing agent (usually a title insurance agency) explains the closing documents, acknowledges the parties’ signatures, accounts for the parties’ funds, distributes the proceeds of the transaction, sends the deed and mortgage to the Register of Deeds for recording, and issues title insurance policies for the buyer and lender. The lender sells the loan to an investor, and the borrower makes monthly payments to the servicing agent selected by the investor. Because the documents are standard, and the roles of the parties are very uniform, nobody spends the time or money to perform much due diligence on the transaction. Hence, it is relatively easy for any of the players (except the investor) to use false documents or parties in the transaction.

Mortgage fraud schemes are extensive, ranging from simple to complex, and are far too common. It is possible to stop a mortgage fraud if one of the parties recognizes the fraudulent features of a transaction before the proceeds of the transaction are disbursed. Some of the more common schemes are:

Inflated income or assets: Some of the most misrepresented facts on an application for credit are borrower income and assets. Recent audits by one lender found actual income was significantly overstated in two thirds of the applications submitted for credit on a "stated income" basis (i.e. the borrower’s income is not verifiable and the loan is approved based on the borrower’s credit score and statement of income). Assets are often misrepresented to make the lender believe that the buyer has funds to make a down payment and to pay closing costs. Sometimes the buyer borrows the down payment without revealing the obligation to repay the funds. A debt may be characterized on the settlement statement as an unrecorded lien, or an invoice for unidentified management services, to hide the fact that the down payment was borrowed. Making false representations in a loan application, or providing false documents to verify income or assets, is a crime. It is also a crime for a mortgage broker or lender to knowingly process a false loan application. False Social Security Numbers: Borrowers sometimes use the social security number of another person, or fake identification documents of a person with "good credit" to obtain a loan. More sophisticated thieves use a good social security number and a fake name ("synthetic ID theft") to make it harder to detect and identify the thief. The first five digits of a social security number indicate the area of the country where the card was issued and the year of issue. These values can be checked against the area of the country where the borrower was raised and the age of the borrower. Altered documents: W-2 forms, bank statements, title commitments, leases, and all manner of documents used to verify income and asset information can be altered or forged. Fake employment verification forms can be purchased over the Internet. Some borrowers forge discharges from their prior lender, or erase the loan from the schedule of exceptions on a title commitment, to avoid paying the balance of their prior loan. Accepting these documents or verification forms from the borrower saves time, but invites fraud. Asking the source of these documents for a separate copy is safer. Multiple loans: Lenders rely on the credit report and title commitment to locate the borrower’s obligations. There is always a "gap period" between the date that documents are submitted to the Register of Deeds for recording, and the date that these documents are available for inspection. There is also a gap between the date of a loan payment (or a missed payment) and the date that information is listed in a credit report. Some borrowers will close two or three refinance loans on a property with different lenders during a "gap period," knowing that the credit report and title commitment will not reveal recent loan transactions and missed payments. Mandatory electronic recording and universal reporting of consumer loan payments to credit bureaus may some day eliminate gap periods. Inflated Deposits and Soft Second Mortgages: Consumers who have an equity interest in their home are less likely to default on their mortgage payments. Hence, most loan programs require a minimum down payment. A buyer may give a false purchase agreement to the lender, showing an earnest money deposit twice as large as the real deposit and an inflated purchase price. A buyer and seller sometimes inflate the purchase price of a home, and offer seller financing in lieu of a down payment, so that the buyer may obtain a larger loan than would be permitted by the lender’s underwriting standards. The seller’s note and mortgage are torn up after the closing. Insisting that all loans be documented and that mortgages must be recorded will reduce fraudulent seller financing. Identity theft: The closing agent relies on the borrower’s driver license or other forms of identification to verify that persons who physically sign the deed, note, mortgage, and other documents have the authority to sell the home and borrow money. Buyers, sellers and closing agents must remember that a forged mortgage is void. Use a "black light" to locate the reflective seal on a valid driver license card. If a person’s identity is stolen, it is important that one of the parties files a police report. The police report also entitles the victim to obtain a copy of any fraudulent financial documents that used the victim’s identity. Straw buyer: A real estate investor may ask a friend or relative, or a stranger, to be a straw buyer (usually for compensation). The real estate investor promises to make monthly loan payments, and to pay off the loan within a year or two. In some cases, a land speculator purchases a home at a low price, and conspires with a straw buyer to sell a home for an excessive price. The net proceeds are used to make monthly payments on the loan and/or the parties split the net sale proceeds and disappear. Besides the criminal liabilities mentioned above for making a false loan application, the straw buyer’s credit rating is ruined when the real estate investor stops making loan payments. Inflated appraisal: The homeowner, seller, or mortgage broker may have an illegal arrangement with an appraiser to inflate the true value of the property, or provide improper comparable sales information to the appraiser so that a loan will be approved for an amount that exceeds the home’s market value. Excessive valuations may be justified using fake pictures of the subject property or property values from other fraudulent transactions. Appraisers should thoroughly inspect the subject property and use comparable property data that they independently verify. Federally chartered lenders must review the appraisal if it is provided by another mortgage lender or by a mortgage broker. Money laundering: It is very easy to prepare and record a forged deed. To launder money, a straw buyer uses illegally obtained funds to buy the home. The title agency unknowingly takes the illegally obtained funds, and issues its own check to the fake seller with good funds. The object of exchanging tainted funds for good funds is to hide the trail of money from its illegal source. The property may be subject to a forfeiture action if the source of the purchase money is discovered. Foreclosure rescue: Avoid offers to "help" a homeowner in a difficult financial situation. The purpose of "saving" a borrower that nobody else considers a fair credit risk is often to "strip" the homeowner’s equity. A homeowner who is facing loss of a home through foreclosure may deed the home to a rescuer, who promises to sell it back at a higher price in a year or two through a land contract or lease with an option to purchase. The rescuer or a straw party (described above) obtains a conventional loan to buy the home. The rescuer may even convince the homeowner to sign over the proceeds of the sale of the home with a promise to pay off other debts owed by the homeowner. The rescuer knows that the homeowner has no means of obtaining a new loan to buy the home back at its inflated price. The investor does not provide any disclosures required by law for these transactions. Courts have held that a deed given as security, and not as a true sale, must be treated as an equitable mortgage. The difference between the amount paid by the rescuer to buy the loan and the price demanded to repurchase the home is interest, subject to state usury laws. Furthermore, these transactions are subject to federal Truth-in-Lending Act disclosure requirements. The homeowner may be able to rescind the transaction and seek the return of the home. Servicing transfers: Federal law requires a lender to send a Notice of Transfer of Servicing to the borrower when mortgage payments must be sent to a different entity or address. Since the content of this Notice is proscribed by federal regulations, a thief can send a convincing Notice of Transfer of Servicing to a borrower, instructing the borrower to send mortgage payments to the thief. Flipping: Frequent sales of a property are not illegal. Higher sale prices may be justified when the property is rehabilitated. However, frequent sales at increasing prices between parties with a hidden relationship can make the property appear more valuable than it is. Sometimes the parties attempt to justify the price increase with cosmetic improvements that hide more serious problems. Flipping is often accomplished with the help of an improper appraisal, a false title commitment, or intentional misrepresentation of the condition of the property. The FBI website highlights the case of a collapsed Detroit home sold one day for $25,000, and the next day for ten times that amount. Occupancy fraud: Mortgage lenders require higher down payments for second homes and investment properties than for a loan secured by a principal residence. To obtain better loan terms, borrowers will state that a second home or investment property is or will become their principal residence after the closing. Inflated Credit History: Borrowers with poor credit payment histories may purchase the right to become a "co-borrower" on good credit accounts ("tradelines"). Good tradelines dilute the impact of the borrower’s poor tradelines, and raise the borrower’s credit score. This scheme is not illegal (yet). Companies that produce credit scoring software are trying to identify these borrowers, to eliminate the impact of the purchased tradelines. Misleading Disclosures: Federal rules require disclosure of a good faith estimate of closing costs within three days after the mortgage broker or lender receives an application for a residential mortgage loan. Borrowers also receive an estimate of the annual percentage rate and monthly payments within three days after providing a purchase money loan application to a lender. However, there is no requirement that this information must be redisclosed if the actual closing costs are different. Some brokers will arrange a subprime loan for the borrower, even though the borrower would qualify for a conventional conforming loan. This does not violate federal law, and the borrower has nobody to blame but himself if he accepts a loan that is not advantageous. However, engaging in fraud, deceit or material misrepresentation is illegal. Providing an estimate of costs to originate a "prime" loan, knowing that the borrower will only qualify for a "subprime" loan with higher origination fees misrepresents closing costs and the cost of credit. A lender or broker violates state law if disclosures are provided for low cost credit, or low cost credit is promised, when such credit is not available to the applicants. Required Use of Affiliates: A seller and his/her real estate broker cannot require the borrower to use a particular title agency for the lender’s title policy if the buyer pays the insurance premium. Hence, it is illegal for a real estate broker or for the seller to require a documentation fee solely if the buyer does not use the seller’s preferred title agency. It is also illegal to require a borrower to use the services of an affiliated settlement service provider if the borrower will pay for the services. Illegal Kickbacks: It is illegal to directly or indirectly pay or receive something of value under an agreement or understanding that the payment is for the referral of settlement service business. It is also illegal to split a fee for settlement services without doing any work to earn a portion of the fee. Some mortgage brokers, lenders and title agencies find it more expedient to pay kickbacks "under the table" to assure business referrals than to generate business based on the merit of their services. These kickbacks, in theory, increase the cost of credit. Failing to Disburse: Some lenders wait until after the loan has closed to finish underwriting a loan. If the borrower fails to meet underwriting requirements, or the loan cannot be sold at a profit, the lender refuses to fund the loan. State law requires that a lender satisfy its lending commitments. Selling Fake Loans: Some unscrupulous lenders create documents for loans that do not exist, and sell the loans to raise capital or hide losses. A lender may also sell a loan more than once to hide losses at the company, or to satisfy credit obligations. The proceeds of the sale may be used to make monthly payments on behalf of a non-existent borrower. Perpetrators of these schemes typically receive stiff prison sentences. Closing Agent Defalcation: Licensed title insurance agencies are required to keep transaction funds in a trust account. There is no requirement that a notary closing service (a "signing service") maintain trust accounts. Employees may steal these funds, resulting in the failure of the closing agent to pay transaction proceeds. Mortgage Elimination: Some borrowers send an "International Commercial Claim in Admiralty Administrative Remedy" to their lender, and file a frivolous lawsuit to discharge their mortgage. This scheme evolved from the repudiated "Bonded Bill of Exchange" given to payoff mortgage loans.

What to do? Mortgage fraud succeeds because consumers do not understand residential transactions. Consumer education will help prevent consumers from falling into these schemes:

• We can strive to teach financial literacy to all consumers. Financial literacy training should be a mandatory part of the high school curriculum. Financial literacy course materials (the Money Smart program) and teacher reference guides are freely available from the FDIC.


• The FBI and the Mortgage Bankers Association recommend that lenders post a sign to warn borrowers that mortgage fraud is illegal.


• Lenders and homeowners should each assure themselves that they have identified a financially responsible party (e.g., the closing agent) who is willing to legally insure the reasonable accuracy of all documents and transactions, i.e, that no fraud has taken place anywhere in the chain.


• Interthinx produced a video, Fraud Scheme Investigation, to help consumers and industry employees recognize mortgage fraud.

We can implement safeguards to prevent mortgage fraud, and to guard against repeat offenders:

• The Mortgage Bankers Association is sponsoring a committee to draft uniform residential closing instructions. These instructions will require the closing agent to be a gatekeeper against mortgage fraud.


• Data mining techniques are used by many lenders to evaluate loan application characteristics against a pool of previously closed loans. These computer programs look for similar transactions that might reveal repeat fraud attempts.


• We should prosecute individuals who break the law. The Conference of State Bank Supervisors and the American Association of American Association of Residential Mortgage Regulators recently proposed a uniform mortgage company and mortgage company employee licensing program (pdf) to make licensing in multiple states easier and less costly, and to allow states to share information about bad actors within the mortgage industry. State oversight of the mortgaging process should be the law in all states, and the oversight process should be adequately funded (probably through a tax on the mortgaging process) and enforced.

Finally, we should draft consumer disclosures that are understandable and meaningful. The Federal Trade Commission released a Bureau of Economics report finding that mandatory mortgage disclosures fail to convey key mortgage costs and terms. Our legislatures must simplify disclosure laws. Disclosures should mandatorily highlight information that really matters to the average home buyer. Some legislatures are proposing to prohibit unsafe or unsound lending practices, and practices that mislead consumers. Better disclosures, and safer lending practices, may help consumers avoid inappropriate real estate and loan transactions.

Normxxx    
______________

The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.

The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

Stock Market— Update

Stock Market— Update [¹]
Click here for a link to complete article:

By Frank Barbera, CMT | 27 October 2007

At the present time, the S&P 500 is somewhat mildly oversold near term, and could be near another short term low. The 9 day RSI for the S&P reached down to a low value, below +30 earlier this week with the S&P holding support near the 50 day moving average and the 20 day lower Bollinger Band (1503). That said, it is important to remember that in emerging Bear Markets, Rule #1 is that surprises come to the downside. Now, we know that there are those who would disagree with our assessment that the S&P is in a bear market. A bull could still point out that the 200 day moving average is still rising, and therefore, that the primary trend of the market is still higher. They would be right, as at the moment, the evidence within the stock market really points to a grand transition phase and the presence of an emerging stealth bear market. In our experience, these types of conditions are usually the hallmark of a stock market that is moving into a full on bear, but the proof of that still waits to be seen in the weeks and months ahead.

For now, all we can do is point out some of the more glaring bearish indications, and let readers judge for themselves the health of the stock market. In the chart below, we show our own version of the DJIA along with its Daily Advance-Decline Line. The daily A/D Line is a cumulative summation of the daily NET of advances less declines within the DJIA. In the top chart, we re-compute the DJIA using our own Unweighted Formula so that instead of a Divisor and arithmetic computation, which favors high priced stocks over low priced stocks, using a logarithmic calculation, all stocks are are weighted equally. The value of our DJIA is arbitrary, and could be set to trade at 500, or 5,000 or 50,000.


Click Here, or on the image, to see a larger, undistorted image.

So the scaling on the chart is not important. What is important, is that the Unweighted DJIA is not at decisive new all time highs to anything like the degree seen in the widely reported DJIA. Re-computing the DJIA, we find the DJIA to be right back to the vicinity of its former January 2000 highs, and running into a lot of price resistance in that zone. Next, let's compare the A/D Line with its 2000 highs, nowhere close is the answer on that one despite a good performance in the last few months. On the positive side, we can also point out that the strong bias toward large cap stocks has been producing a robust undertone within the DJIA, which has been reflected in a strong A/D Line moving to new higher highs in recent weeks. Next, let's look at the Dow Jones Transports. Notice that unlike the DJIA, neither the traditional Transportation Average, nor the GST Unweighted Transportation Average were anywhere close to confirming the new “all time” highs in the DJIA. On a Dow Theory basis, this is the kind of bearish divergence that often signals a major market peak.


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In his fine efforts at "Cycles News and Views", market analyst Tim Wood notes that going back to 1896, there have been 27 four year cycle tops, with the current cycle potentially marking the 28th four year cycle top. During the prior 27 four year cycles, a bearish divergence between the Dow Transports and the Dow Jones Industrials marked 81% of those prior tops. Over the course of the last two to three months, that type of action is exactly what is taking place, with the Advance-Decline Line for the Dow Jones Transportation Average presently very close to a major breakdown below support.


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Above: the Unweighted DJ-65 Composite, could be finishing off the "right shoulder" of a major peak.


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Above: the Unweighted DJ-65 (upper), the Unweight DJIA, then the Transports and Utilities (lower). Only the DJIA made new highs in Sept, with the other averages failing to confirm.


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In addition to the obvious bearish divergences between the averages, we can also point out that with even the Dow Jones Industrial Average, overall participation in the advance has been thinning. For example, when the Dow went to new all time highs in July, nearly 86% of the DJIA 30 stocks were above their own 200 day moving averages. Flash forward to September and the latest round of new highs on the DJIA, and only 73% of the stocks were above the 200 day average. Looking at the other two averages, the Transports and the Utilities through this lens, we see that with DJIA hitting new all time highs in September, LESS than 50% of the DJTA average stocks were even above the 200 day average. Ditto the 15 DJ Utility stocks where more then half the list was below the 200 day average. We don’t know if that degree of failure has ever been seen before, but it certainly suggests that the market notwithstanding the CNBC Bobble-head cheerleading is not in good shape technically.


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Above: the Transports with Percent of Stocks above the 200 day average, less then 50% at the recent all time high in the DJIA, and Below: same thing for the Utility Index. These later two indices often lead, and that cannot be a good message for the market.


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As a result, we continue to suspect that the stock market is not far away from serious trouble, as looking at the four Dow Averages, the DJ-65 Composite, the Industrials, the Transports and the Utilities, ONLY the DJIA made new all time highs in September, and now, with prices reversing sharply lower, the odds are growing that the September high may have been a final exhaustion peak for the major indices.

Elsewhere, we also want to point out that over the last two years, the US Railroad Industry has thrived as a result of US-China Trade. Over this time, railroads were seen as the extension of the ports, which they are, and moved to P/E multiples not seen in years. In many ways, the rise in China as measured by the surging Shanghai exchange has been paralleled by the recovery in US Railroad fortunes. If demand is dropping off in the US as a result of a consumer led recession, then perhaps the recent downturn in the Transports, and especially the Rails, is an ominous sign for the fortunes of the Chinese Stock market, as the US Consumer has been a key source of aggregate demand. In addition, the Shanghai Stock Exchange, which has unquestionably held up longer than we ever imagined, appears to have completed its five wave advancing pattern, but to be sure, we need to see another three to four percent decline. The momentum profile on Shanghai looks very bearish in our view, and a break in the Asian stock markets where we have seen a speculative mania would be a very big negative for other global markets, including the US.

As another foot note, we also note that European stock markets like the DAX, CAC and FTSE, really lagged the US, perhaps a strong Euro biting into market share, with European ministers pointing the anti-free trade finger at China over the last few days. Protectionism and negative sentiment is rising against China, with the US and Europe now joining in against low priced Chinese goods and an undervalued Yuan. If there ever was a case of "be careful what you ask for" pushing the Chinese to revalue the Yuan has to be it. Attention Wal-Mart shoppers, everything in the store is about to get a lot more expensive once the Yuan revalues…


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Above: Shanghai with US Railroads.


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Above: the Shanghai Composite with a very clear five wave pattern, the final high looks to be in place and with a few more percentage points on the downside, we can start to make a bear case for China.


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Above: A double failure pattern on the medium term RSI for Shanghai, this can’t be good. Momentum peaked back in late 2006, and then made a first failing high in April - May 2007, and now a second failing high in Sept - October 2007.

To date, Asian stock markets have held up longer than we expected, but the roll over in RSI in recent days smacks of something more serious afoot. While some of the Hong Kong ‘H’ Shares still appear as though they could hold up and make token new highs over the next two to three weeks, overall, the vertical nature of the move appears to be very late in the cycle. In our view, a break in the Asian stock markets— perhaps in November or early December would be very serious and could accelerate the outcome to the downside for the US Equity and other International markets leaving us with a mindful approach to investment risk at this late date in the cycle. That’s all for now.

  M O R E. . .

Normxxx    
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