Certainty Helps Stocks / Housing

A: I hope everyone enjoyed their labor day weekend! Lets get back to work. Big happenings on Friday that I want to catch up on. There were 3 angles at work to help ADD SOME CERTAINTY to the tradable markets and housing: Bush, Congress, & the Fed. I'm going to shy away from my personal feelings on this changing landscape (as I'm not so sure the proposals put forth will help all that much) and issues of moral hazard for a moment so we can see what this all means for future investment strategy.

The News: President Bush took the spotlight off Ben Bernanke on Friday before labor day weekend to announce his outline for help in the subprime housing world. His initiatives will target delinquent subprime borrowers.

According to CNN Money:

The proposals put forward by the president included increasing the help offered by the Federal Housing Authority to troubled borrowers. That may take the form of expanding the pool of borrowers who can apply to the FHA to refinance their loans.

The president wants to work with Congress to temporarily suspend the tax liability that can take effect when borrowers lose their homes through short-sales, and when lenders forgive mortgage debt. That will enable borrowers to more easily rework their loans.

The president also wants to press efforts to combat predatory lending where unscrupulous mortgage brokers and lenders take advantage of naive consumers by steering them into mortgages that are extremely profitable for the brokers and lenders but ultimately unaffordable for borrowers.

In my opinion, even if these actions take place it will analgous to placing a band-aid on a gunshot wound. It may stop some bleeding, but it will not heal the wound! Some of the side effects of both Bush's and Bernanke speeches plus some things to note include:

Stocks Surge - Certainty creeps back into trader psychology for now giving stocks a lift. Whether it holds is another issue.

The Big Picture - no, not Barry Ritholtz's blog. Right now a rate cut is priced into stocks. So, if we get one, I worry that a selloff may occur as traders realize that the monetary policy move now means that threats to the economy are starting to show. In addition, if we do NOT get one, stocks will be disappointed. What I'm saying is that I think negative sentiment outweighs positive sentiment as the near term unfolds. This is a constantly changing dynamic of tradable markets and is best explained to you guys by the old saying, "buy the rumor, sell the news"; which means investors bully up shares in a company stock BEFORE the announcement, and SELL OUT after the announcement.

Commercial Paper Market Very Slow - No matter how you cut it, corporations are not able to sell company bonds as easily or as efficiently as they used to due to rising risk. There just aren't as many buyers out there and that means company's that utilize leverage to make earnings have less options available to raise cheap cash. As Bloomberg reports, "Commercial paper, a short-term financing tool, declined by $244.1 billion, or 11 percent, in the three weeks to Aug. 29, the most in at least seven years, Fed data show"

US Dollar Weakens - With psychology focused on rate easings, the US dollar had little support. A weak US Dollar helps maintain foreign demand for NYC real estate investments via currency trends. I just don't see how the fed can engage in a aggressive rate easing campaign & maintain price stability with the US dollar at the same time? If the fed cuts, our currency will begin a new leg downwards in value.

The Moral Hazard Issue - I just can't help but jump on this moral hazard bandwagon. For all those that don't know what moral hazard is, let me sum up.

Moral Hazard, in regards to finance, refers to the psychology of investing for risky bets; usually the greater the risk the greater the reward. In this case, for those that take big risks, what if someone is there to BAIL THEM OUT (i.e. the fed, taxpayers, congress, etc.) should the investment bet not work out? So, the reward side offers great upside potential, and now the downward risk side is diminshed as the investor will not have to bear the full burden of losses! Its a moral hazard. What is to stop this investment behavior from exponentially occurring down the road if investors know that they will be bailed out if the bet doesn't work out in their favor?

Here is the web definition of moral hazard: A moral hazard arises if lending institutions believe that they can make risky loans that will pay handsomely if the investment turns out well but they will not have to fully pay for losses if the investment turns out badly. Taxpayers, depositors, other creditors have often had to shoulder at least part of the burden of risky financial decisions made by lending institutions.

I just don't see the fed aggressively acting in 2007 unless the jobs data deteriorates significantly! If they do, my near term prospects on the economy will become very gloomy! That's not to say that I think this credit squeeze is over or that it's full effects have been absorbed yet. Not so. I think we have major issues under the surface that can negatively effect jobs and consumer spending, but the data is not significantly showing that yet. Since the fed MUST be right about rate actions, they can't afford to be ahead of the curve on this issue and risk pumping too much liquidity into the system for a problem that the free markets could have handled on their own! And that means taking a wait-and-see attitude towards monetary policy and risk being behind the curve!

Only one problem: We will BE IN A RECESSION before any major action is taken! One reason why I don't buy into this stock market rebound OR to support the argument that the rebound is artificial is VOLUME! In the last 3 trading days the DOW is up about 350 points on light volume. That tells me there is little conviction behind the buying. Lets see how this plays out as I have often stressed the importance wall street (wealth effect, jobs, bonuses, and salaries) has on Manhattan real estate. For now, lets enjoy the comfort of slightly more certainty (however long this will last for) that comes with knowing the fed and Congress are ready to act if needed to help prevent the economy from falling into recession.

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That Pesky Libor Rate Hits 8-YR High

A: It's a misperception out there that borrower's lending rates and adjusted mortgage rates are based on fed funds target of 5.25%; not so as I have pointed out before here on urbandigs.com. Instead, lending rates are based more on the bond market while all those adjustable ARM loans are based on the LIBOR rate, which is now at 8 1/2 year highs. That means if you have an adjustable rate mortgage and the fed cuts the target rate, you MAY NOT feel any relief! If LIBOR continues to stay at these heightened levels, resetting ARM's will face significantly higher monthly payments when the lock in expires. Lets discuss.

This is important because many resetting adjustable rate mortgages are based on the LIBOR rate. I discussed LIBOR previously in my post titled, "Global Feds, LIBOR Rate, & Fear Continues" back on AUG 10th where I stated:

It's an index that is used to set the cost of various variable-rate loans, including credit cards and adjustable-rate mortgages.

Recently, this LIBOR rate has been moving higher; a bad sign for all those with adjustable rate mortgages that are resetting to current LIBOR rates. If you are a resetting ARM holder, you may see your monthly payments jump even higher.

According to an article today in Forbes.com:

The costs for banks of borrowing money over a three-month period hit another eight-and-a-half year high today as the credit crisis sparked by losses from US sub-prime mortgage investments made banks increasingly unwilling to lend money.

The London interbank offered rate (Libor) fixing for three-month sterling deposits -- the rate at which banks lend to each other -- jumped to 6.79750 pct, the highest level since late 1998 following the collapse of the hedge fund Long Term Capital Management.

That is the 3-Month UK sterling LIBOR Rate. The overnight dollar LIBOR fixing rate rose to 5.65%, while the overnight Euro LIBOR rate were fixed at 4.14%. Let's see how any future fed action or gov't action may help to relieve the rising LIBOR rates for the estimated $355B worth of home loans set to reset in 2008 alone! And from what I am hearing, that is a conservative estimate. I recall reading in another source that the expected value of home loans set to reset in 2008 was closer to $600B, but for the life of me I can't remember where I read that.

Something to keep an eye on as more distressed homeowners who can't afford their payments means more defaults, more foreclosures, more risk in mortgages, less interest in secondary mortgage markets, even tighter lending standards, etc..The trickle effect is a long one and I think it is safe to now say that 2008 poses the most important test for housing in the past 15 years or so.

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Studio Vision: Hide The Bed!

A: A great piece from the NY Times on Sunday about thinking outside the box to maximize the space in a studio apartment. The article was about a pair of Manhattan architects who bought a studio in Tudor City. Their plan? Maximize the space of a straight studio by hiding the bed! Such a simple concept that most buyers think to do in the form of a murphy bed. But not these two. For all you studio buyers out there, this one is worth it especially if your plan is to buy and renovate your new home from scratch!

NY Times: Updating The Trundle Bed

First job, find the right studio for the right price! Since your plan involves spending a good amount of money on renovations, you need to make sure the studio property you buy is priced right given the condition it is in! Don't let the selling broker fool you into paying top dollar for location, light, or views! Instead, understand that the renovation process is a big burden for any homeowner and that you will have to deal with blueprints, architects, co-op boards, contractors, and the side effects and time it takes for construction. All of this is the reason why major renovations to kitchens, bathrooms and flooring often pay the homeowner MORE THAN DOLLAR VALUE back at resale; especially when the job is done right!

Next, hide the bed! No, that doesn't mean a murphy bed as that is not hidden! A murphy bed, for all those that don't know, is a piece of furniture installed against a wall that houses the bed. When you need to use it, simply open the furniture door and pull the bed down. When you're done, lift the bed back up and close the furniture doors! But the problem is the amount of space lost with the actual piece of furniture that houses the bed itself. The pull down method is the problem. So what to do?

Build a raised platform and hide the bed underneath! Think 'slide-out' instead of 'pull-down'! Why didn't I think of that!

As you see in the illustration to the right, these two creative thinkers built a raised platform at the back end of the studio that can be used as either the living area or dining area of the property. It doesn't matter! What matters is that the bed is built to slide underneath, removing any obtrusive murphy beds from existing on one of the walls. By building this way, the studio maximizes space, can have both a living and dining/office area comfortably, and will most likely appeal to future buyers as this type of construction is certainly not the norm in a positive way.

All in all, the cost of the total renovation for the raised platform (which I assume included a new wood floor as well to go with it), new kitchen, and new office space cost $75,000. Not cheap by any means, and certainly a cost I think could be beaten with the right contractor!

How did they think of the idea of a sliding bed? They went out for a bite to eat, of course:

"We were frustrated thinking of all these different solutions, and we got hungry," Ms. Yanagishita said. "We went to have Korean food in a restaurant on 32nd Street. We were eating kimchi - pickled cabbage - and we noticed the raised platform we were sitting on."

"Then all the little pieces came together like a Japanese puzzle box: things slide out, things fold in, things tuck away. It is clean, we hope, without any fussiness."

Good stuff for any studio owner seeking a more creative way to make more efficient use of the little space they have!

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Jumbo Rates Still Surging / ARM's Too

A: Weekly Mortgage Report from Wells Fargo (hat tip Michael McGivney) shows falling 30YR fixed rates but rising ARM rates across the board. Any buyers out there care to report what they are seeing after talking to their mortgage lenders? Lets see how consistent this report is with other brokers doing lending business in Manhattan!

First, some charts via the Wells Fargo report. Here are weekly rates check, unfortunately it doesn't show jumbo rates, I'll get to that shortly.

Here is a chart showing Home Sales data as released by NAR.

Now, onto the Jumbo rates that are more in tune with reality here in the world of Manhattan real estate. Michael McGivney is reporting to me another surge in Jumbo Loan rates for 30YR fixed loan products reflecting the increasing risk seen by lenders towards the mortgage markets.

The exact quote from Michael is...

"Jumbo rates are awful; 30 yr at 7.375% - 7.5% depending on LTV and credit. It is 0.125% higher than last week"

For all you that don't know, LTV is Loan-To-Value ratio. This is important because depending on how much you can put down, your rate quote can be lower or higher. Less money down means MORE risk for the lender and therefore a higher rate. More money down means LESS risk for the lender as the borrower is willing to take more equity in the transaction; this will give the borrower a better rate.

In addition, short term ARM product rates are rising because quite simply the risk is increasing for this type of loan product and fewer investors are willing to buy these riskier loan products on the secondary mortgage markets. That means lenders may be stuck holding the bag and that is something some don't want to do. According to the report:

Treasury yields dropped on AUG 30th as investors fled asset backed commercial paper in favor of the safety of government debt. The credit market situation is becoming quite unpredictable, with reports coming out almost every day detailing further ills for companies and the market as a whole. The housing market remains in a deep slump while consumer confidence is waning. We expect these factors to keep downward pressure on long-term mortgage rates in the near term. However, shortert-term ARM rates rose sharply this week and will carry upside risk as liquidity has dried up for these riskier mortgage instruments.

Great stuff from the inside trenches of the lending world here in Manhattan. WHAT ARE YOU BUYERS SEEING OUT THERE WITH RATE QUOTES? IS THIS REPORT ACCURATE OR OFF?

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NAR: Mortgage Disruptions At Work

A: Pending Home Sales Index falls sharply to a reading of 89.9, a 12.2% decline from June's reading, as mortgage commitments failed to come through on some deals. This should not be a shock to anyone that has been keeping pace with this rapidly changing lending environment of tighter loan/underwriting standards, fewer loan options, higher interest rates, and a dried up secondary mortgage market. It pays to know how macro affects certain markets!

Here is a chart showing the last 12 months of the pending home sales index:

As many buyers know, getting a loan pre-approval does NOT mean you got a loan commitment; I've said numerous times that Pre-Approvals mean sh*t!. The basic path of the process is this, which explains what happened here for the sharp falloff in pending home sales index:

BUYER GETS PRE-APPROVED FOR LOAN ---> BUYER BIDS FOR HOME --> SELLER ACCEPTS ---> DEAL GOES INTO CONTRACT ---> LENDER SENDS APPRAISER ---> UNDERWRITER GATHERS DOC'S FROM BUYER TO SATISFY CONDITIONS OF COMMITMENT ---> WALK-THROUGH ---> CLOSING

I BOLDED the uncertain areas of the loan process that can lead to a buyer not being able to get their loan commitment, and therefore no mortgage. No mortgage, no deal. Most contracts are structured with a finance contigency; that is, the deal is contigent upon the buyer receiving financing. If the buyer can't get financing, for whatever reason, the deal is voided and the security deposit returned to buyer.

A lender can get out of committing to a loan IF:

* Buyer doesn't satisfy conditions of commitment. One way this could happen is if buyer fails to prove financial state with supporting documents required by lender.

* Property appraises BELOW purchase price. Buyer refuses to put up extra money and can not get the commitment for the loan at the current purchase price. Either the deal is re-negotiated at appraisal price, or deal is not done

According to the NAR's statement following the release of this Pending Home Sales Index:

Lawrence Yun, NAR senior economist, said abnormal factors are clouding the horizon. "It's difficult to fully account for mortgage disruptions in the index, and our members are telling us some sales contracts aren't closing because mortgage commitments have been falling through at the last moment," he said.

"If lenders focus on the essentials of creditworthiness and adjusted valuations based on comparable sales, and ignore speculation on what might happen in the future, broader stabilization will come sooner rather than later," Yun said.

Okay. So all lenders have to do is focus on the essentials of credit worthiness and avoid speculating on what may happen in the future? Are you kidding me? If this were to happen, 50% of buyers outside Manhattan wouldn't get a loan given the current environment!

Folks, what you need to know about this leading indicator of future existing home sales, is that the end is NOT NEAR! This reading is telling us that future existing home sales data is likely to be bad and that a growing reason is because lenders have been tightening underwriting standards and are starting to BAIL from committing to the deal right before closing, read my posts "Living In A Tougher Lending World" & "Insider Mortgage: Underwriting Standards" where I discussed this ! Whether that it is because the property is appraised at a lower value than the purchase price OR the buyer doesn't meet commitment standards for the deal is the question! Either way, it's not too good for anybody and is just another leg powering the housing downturn process.

Don't believe everything you hear from these types of organizations; I don't care what my colleagues or my employing brokerage has to say when I state this. Buyers and sellers deserve to know what is going on and should be given unbiased analysis of the data that is presented. Transparency is key to savvy investing and this dataset simply implies that the mortgage markets are still in turmoil, standards are tighter, underwriting means something again, appraisals must come in from unbiased third party, and some deals are going sour. Done and done. Spinning it any other way loses credibility in my opinion.

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Subprime: Who's Fault Was It?

A: Interesting piece here on CNN Money about whose fault it was to put us into this credit squeeze mess resulting from defaulting subprime borrowers. Who's fault do YOU think it is? Lets discuss the list of suspects along with my take on the blame that should be assigned to them.

CNN MONEY: LET THE FINGER POINTING BEGIN!

The Borrowers - 3/5 Fingers Pointed

YES! More than 3 fingers should have been pointed to this group! Stupidity is a scary thing. Well, at least it scares me. When a buyer makes a rational investment decision to buy or speculate on real estate when the numbers just don't work, it's hard to lay blame elsewhere; although in this case there are others to blame.

But for me, alot of the problems had to do with bad decisions made by home buyers who bought either too much house, or tried to jump on the appreciation bandwagon to make a quick profit. In both cases, the buyer is the one to blame. Too often people get emotional and buy something they cant afford, whether it be a car, a piece of jewelry, a vacation, etc.. Thats the person's fault! Good investment decisions are made without emotion and take into account your personal financial situation, job security, and investment strategy. Buying a house with 100% down, very little liquid assets, and a salary that just won't make the payments work is pure stupidity!

Fact is, too many people bought a house and were duped by exotic loan options (I don't forgive brainwashing or being sold a loan product as an excuse here) because they didn't think things through and let their emotions dictate the decision.

The Mortgage Brokers - 3.5/5 Fingers Pointed

About right, but more of the blame should be put onto the managers of these brokers who put pressure on the employees to bring the deals in! You can't blame the brokers for doing their job but you can blame them for misleading the public with ultra-risky exotic loan products that they sold to the borrowers.

Still, in my opinion the lenders and managers of these employees should bear more burden.

The Appraisers - 2/5 Fingers Pointed

It was all Jonathan Miller's fault! Obviously I'm joking. I would even go as far as to lower this to a 1/5 fingers pointed in terms of blame. Appraisers usually do what they can to make the numbers work, no doubt about it, as the entire deal is dependent on it; buyer, seller, re broker, buyer attorney, seller attorney, etc.. If the number doesn't come in, then no one gets their cut of the deal! So there certainly is some pressure. But, fact is housing was appreciating at a very fast pace and the definition of market value is the value that a buyer is willing to pay for a property. So, as long as the comps are somewhat in-line, the # usually came in where it needed to be.

Plus, so many different variables go into an appraisal such as location, school district, renovations, etc.. that it's hard to NOT make the # come in unless it is absolutely out of whack with current local market conditions.

I put the least amount of blame on the appraisers out of this bunch.

Mortgage Lenders - 4/5 Fingers Pointed

YES! With a few phrases I can sum up why: Lax lending standards, lax underwriting standards, the pushing of risky exotic loan products to make payments more attractive, a 'look the other way' attitude towards ultra risky buyer applications, and the incorrect notion that they can always sell the loan on the secondary mortgage markets should things get hairy.

Mortgage lenders and their super loose standards from 2002-2006 definitely played a role in where we are at today.

Wall Street - 4/5 Fingers Pointed

Hmm, tough one. But I'm going to give wall street a break here. They shouldn't be blamed this much. Why? Because financial innovations, such as CDO's and CMO's and other mortgage backed securities that are traded on the secondary mortgage markets, provided the consumer with more loan options? These innovations are what allowed the banks and lenders to relieve themselves of loans so they could provide more options to consumers with the now freed up funds.

While there is some blame to put on the system and all the fees that are made behind the scenes (which many brokerages and hedge funds too great advantage of), but I do not think this was the source of the problems we are in now.

Because of this mess, these secondary mortgage markets are now in turmoil and dried up. This is bringing us back to a state of normalcy where lenders don't have the options they once had to relieve themselves of loans on the books. It is this system that is allowing the free markets to correct themselves, and YOU the consumer are now seeing the end result of this adjustment in the form of tighter lending standards, tighter underwriting, higher rates due to risk and fewer risky loan options at your disposal.

Rating Agencies - 4/5 Fingers Pointed

YES! First off, the unhealthy relationship between wall street bigs and the rating agencies provided for this problem. Just way too much conflicts here to not have a problem.

If the rating agencies were more accurate as to the changing environment, wall street would have been less inclined to take on so much risk; at least I like to think this way. At least it would have minimized the pain as many insurance companies, pension funds, and mutual funds have restrictions on the type of investments they can make for below rates securities.

So, by dropping the ball on ratings, the agencies in essence allowed this risky environment to persist way longer than it should have! Definitely some blame here.

The Federal Reserve - 4.5/5 Fingers Pointed

YES! Oh Alan Greenspan, how your legacy has changed in the past year or so. When Easy Al enacted his ultra loose policy and brought and left the fed funds rate all the way to 1%, he allowed so much liquidity to be pumped into the system that future problems should have been forseen. In addition, he promoted the use of risky loans by homeowners; i.e adjustable rate mortgages.

Sure he was considered 'the man' back in the day and did do some great things to help stave off big time financial distress, many are now blaming the fed for allowing such loose monetary policy for such a long time. As rates started to rise incrementally (mainly by 1/4 point hikes over a 2+ yr period), many are now arguing that Greenspan should have raised rates much more aggressively and faster to counter the growing asset bubble in housing. But that didn't happen and the national housing bubble grew even bigger until its inevitable pop!

Hard to argue that cheap money had nothing to do with it! It changed the psychology of investors and the game itself, and let everyone assume that the housing money machine will never stop printing. Its ironic that today we are calling for the fed to lower rates to help ease the side effects of the problem that arose due to cheap money in the first place!

What do you think? Who's to blame? Anyone missing from the list? REAL ESTATE BROKERS PERHAPS? Did UrbanDigs cause this whole problem? Hmmmmmmmmmmm!

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Back Tomorrow

Sorry guys. I've been in FL since Friday morning on business and visiting some friends/family. I have lots to discuss about the awful jobs report on Friday and how the macro environments has changed. Readers know I have been on record stating weak jobs towards the end of 2007 was one of the biggest threats to Manhattan housing. Now that it hit national, lets see how it hits us at home.

Working on post now to get caught up, but I may not have time to publish until I get back to NYC tomorrow. Sorry fro delay publishing comments, I am working on upgrade to urbandigs.com that will fix that feature and add more functionality to this blog for readers! Should be ready in a month or 2.

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Jobs Weaken Big Time / Fed Cut Likely

A: Oh boy. On Friday, the BLS issued an absolutely AWFUL jobs report that brought us the first negative jobs # in 4 years, and also restated jobs data downard for the months of June & July! Just an awful report no matter how you cut it. Some may ask why stocks fell because that all but locked in a fed cut very soon; the reason is the stock market ALREADY priced in rate cuts and the news of the already weakening economy now means a recession is a very real possibility. Stocks had to adjust. Lots to discuss here to get all those interested in the macro side of things up to date. Sorry for the delay while I was away since Friday.

First the very disappointing jobs data. According to CNN Money:

The number of Americans with jobs fell in August for the first time in four years, according to Friday's government employment report, raising fears that weakness in the economy has spread beyond the housing and financial sectors that have roiled markets in recent weeks.

The Labor Department report showed was a net loss of 4,000 jobs in the month, down from the 68,000 increase in July, which was also revised lower. Economists surveyed by Briefing.com had forecast an increase of 110,000. The household survey actually showed an even larger drop in the number of Americans saying they had jobs - a drop of 316,000.

Job losses were mostly fealt in construction, manufacturing, and government services while health care and education showed the most strength. We STILL are yet to feel the full effect of job losses resulting from residential construction + credit mess and associated lenders/brokerages/financial services who are in big trouble. I worry there is more pain to come. However, because NOT ONLY AUG was bad but June & July were revised downwards as well tells me that we are already dealing with a weaking economy! That means the fed is now BEHIND THE CURVE and all but locks in a rate cut at their upcoming meeting. The question is whether it will be 1/4 or 1/2. Lets go back a bit for a moment.

For the longest time, I have been stating that the two biggest threats to housing were:

1. Tighter Lending Standards
2. Job Losses

...in the following posts:

DEC 28th, 2006 ---> Housing Data In: Not Too Shabby But...

JAN 2nd, 2007 ---> Predictions Post

JAN 25th, 2007 ---> Existing Home Sales & Foreclosures

MARCH 1st, 2007 ---> Why Lower Rates Might Not Be Good

Then, on AUGUST 17th, about 3 weeks AFTER the credit squeeze came to a head, I had to alter my two biggest threats (in my post titled, "Time To Talk Global / Consumer / Jobs") as tighter lending standards and the credit crunch came true. So, in the post I stated that my NEW two biggest threast to housing were:

1. Global Growth Slowdown Amid Credit/Liquidity Crisis
2. Job Losses

Keep in mind that at the time I wrote the above post, jobs data showed some signs of slowing but nothing drastic! Well, that ALL JUST CHANGED ON FRIDAY! I mean, on September 4th, 3 days before that jobs data even came out, I publicly stated to you in the post, "Certainty Helps Stocks / Housing" that:

"I just don't see the fed aggressively acting in 2007 unless the jobs data deteriorates significantly! If they do, my near term prospects on the economy will become very gloomy! That's not to say that I think this credit squeeze is over or that it's full effects have been absorbed yet. Not so. I think we have major issues under the surface that can negatively effect jobs and consumer spending, but the data is not significantly showing that yet."

I couldn't have been more clear about that! Now, jobs are being lost not only last month, but for the past three months now! That fits into the statement of "deteriorating significantly" in my book and changes the macro environment and future fed policy.

Now that all the red flags I've been discussing for so long are finally hitting the jobs market, I expect the fed to act, and act rather aggressively until we get to the end of the year! The moral hazard question is a valid one as no one wants a fed with the reputation of bailing out those who make bad bets. But, this jobs report now gives the fed actual evidence of a weakening US economy so that they can make a rate cut without their credibility questioned.

I have to adjust my biggest threats to housing once again as both my original predictions (tighter lending standards/credit crunch + jobs losses) have now come true. The two biggest threats to housing I now see are:

1. Global Growth Slowdown Amid Credit/Liquidity Crisis
2. Insolvency Crisis - Inability to pay back debts; assets no longer exceed liabilities

I'll discuss #2 when I get back to NYC. My biggest fear now is that a slowdown is here in the US economy and even worse, it will SPREAD TO GLOBAL ECONOMIES! Globalalization has been such a major factor in the growth of US corporate profits and ultimately stocks for the past few years. If we remove that equation, we will be entering a period of stock market corrections, more layoffs, negative wealth effect, change in consumer psychology, and big cutbacks in bonuses and salaries. This has NOT happened yet! I often say this when I make these predictions as I did with my past ones.

Let's see how it works out. I want to get this post up without the fine tuning I usually do or adding any image to portray the emotion of the post. So, hopefully you'll be able to read the entire thing without falling asleep. I'll get into this more this week as these are real issues, real problems, and housing is the end result of all this in the macro food chain! Questions I now have are:

1. Any fed move will be behind the curve. How aggressive will they be? I worry it won't do that much other than cushion the carnage to the economy in the years to come! It will NOT help the illiquid credit markets or the damage that is yet to come from this problem.

2. How LIBOR rates may be affected, if at all, for ALL those ARM resets & credit debt holders in 2008 and beyond?

3. When will brokerages/lenders/hedge funds ALL come out with their holdings related to mortgage backed securities? Who's holding what? There is still no liquidity in secondary mortgage markets leading me to believe more pain is to come?

4. Global connection to US subprime mess and illiquid secondary mortgage markets? Will that cause the global slowdown?

5. Consumer? How will spending restrict? How will sentiment/psychology change?

6. Insolvency Crisis? How many bad debts are out there in the hands of consumers, lenders, hedge funds, brokerages, corporations that won't be able to be paid back? With a dried up secondary mortgage market and a very slow commercial paper market (corporate bond market), what will happen when margins are due?

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New Listings Inventory Check

A: I wanted to follow up on the # of NEW LISTINGS that have hit the Manhattan real estate market by month since the start of the year. I posted on this trend back on July 6th, where I expected the month of July to ultimately show a significant decline from the month of June. While there was a decline, it wasn't as significant as I originally thought it may be. It's important to know that I do the best I can with the data that is available to me. In this case, New Listings are the most error-free dataset I can trend out. Hopefully in near future I can change this so you guys have access to data and charts that I feel would be incredibly useful for buyers/sellers.

Neighborhoods included: Beekman, Carnegie Hill, Central Park South, Chelsea, Clinton, E. Village, Fin District, Flatiron District, Gramercy, G Village, Little Italy/Chinatown, LES, Midtown, Murray Hill, SoHo, Sutton Area, Tribeca, UES, UWS, W. Village

Lets get right to it. Here is a chart showing you the # of NEW LISTINGS to hit the Manhattan marketplace each month in 2007; I included September so obviously discount that category. However, today alone I see 74 NEW LISTINGS! This month may prove to be significant towards affecting inventory trends down the road here in New York City.

Conclusions - Hard to say. To me, inventory out there still seems tight and prices holding; properly priced apartments are selling relatively quickly while those that are pricing high and testing are experiencing the normal lengthier time on market. If September proves to have over 1,000 new listings hitting the market, that would make two months in a row of 1,000+ new listings hitting the market here in Manhattan. There are a few new development listings that seem to be contributing to some of the most recent inventory (about 80 or so updated last in past month). These include listings for:

1. 255 E 74th
2. Atelier - 627 W 42nd
3. William Beaver House - 15-23 William St
4. The Brompton - 205 E 85th

How many are truly available at this very moment OR set to be released in near future I don't know. To get this info simply contact the sales office for an updated inventory list and ask how many percent sold the building is.

Looking forward, I hope to make this data easier for you guys to chart out and interpret so you have a better take on the Manhattan marketplace. Please bear with me while I work on urbandigs phase 2; del boca vista.

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The Psychology of Asset Cycles

Back in May no one was too worried about several trends that were bothering me and I cited an old Wall Street maxim that "its the stuff no one is worried about that kills you". At the time the housing bubble popping was well known and Chairman Bernanke of the Fed, Treasury Secretary Henry Paulson and the CEO of Bank of America had all recently commented that the housing downturn was, bottoming, petering out etc. Silly me. I didn't even mention the housing downturn in my piece "Black Monday 20 Years Later: What Me Worry?".

I was more concerned about the toppy buyout boom (recall Noah's post in July on "Buyout Boom Brings Reason To Worry"), slowing profit growth, productivity declines, a weak dollar and bond market, and general debt levels. But what was really bugging me was psychology, overall and the lack of anyone seeing the parallels to 1987 including a flurry of insider trading, other countries "diversifying away from our government bonds" (add Japan to this list as of last week) and seminal top marking type deals like the Blackstone IPO. As the sub prime debacle has been playing out I have been quiet in terms of submissions to the site. For one thing, I have found that it's a losers game to make sweeping calls in the midst of a market crisis, because you lose credibility. In 5 minutes everything can change and you look like a knucklhead. Secondly, my research has been focused outside of the Manhattan real estate market lately and since I don't personally have the warm and fuzzies on real estate generally, right now I don't want anyone thinking I am touting any particular neighborhood as immune from what may be coming to the Big Apple. OK sorry for the pre-amble. Forget what's happening today in the markets and forget about data - there will be none in my piece - lets talk about the psychology of market cycles.

In the beginning people hate a certain asset because they were burned by a horrific decline. Think tech stocks in 2003, real estate in 1993, oil in 1998.

THE MAGAZINE COVER INDCATOR:

The bottom is usually struck with some major publication saying the asset will never recover. The Economist proclaimed "Drowning in Oil" on its cover in early March 1999. If you bet everything you had on Black Gold that day, your rich and retired (not that I would have advised that). Paul McCrae Montgomery, president of Montgomery Capital Management invented the Magazine Cover Indicator after studying its correlation with peaks in markets. His premise was that by the time a major investment trend makes it to a magazine cover the best money has already been made. Interestingly it seems to mark bottoms pretty well. Newsweek magazine marked the bottom of the late 1980's / early 1990's collapse in the real estate market with its October 1990 cover, "The Real Estate Bust,". Interestingly, in a 2005 interview McCrea avered that magazine covers proclaiming the golden age of residential real estate, were not signaling a bust because Wall Street had not already over-exploited the trend as it usually does. Little did he know - but I'm getting ahead of myself.

THE LIFT-OFF PHASE:

The next part of the market cycle is the low risk high return phase. This is when the asset, which had grown above trend line growth, then suffered several years of below trend line growth, accelerates back to normal or slightly above normal growth. Say for example the normal rate of telecom equipment spending growth is 5% per year but it goes to 15% for 3 or 4 years, then its negative 20% to 30% for a couple of years, but finally recovers to 7% to play catch up. This is the best part of the cycle for investors and many miss it because they still hate the asset. Now things normalize for a while, which could be 5 to 20 years. It took ten years for oil to kind of stabilize after the 1980s debacle. Residential housing didn't start to get hot until the very late 90s after peaking in the late 80s. These long rest periods are important because many people who were around and had direct experience of the asset crashing leave the business, retire or die of boredom. Next things start to get rocking due to some new big catalyst like China turning commodities (what was viewed as the biggest losers game in creation) into the next big thing. As the rocking turns to rolling, trend following investor types start to get involved - unfortunately this usually includes the individual investor who invariably gets burned.

LEVERAGING UP & RELAXING STANDARDS:

The people doing acquisitions, and supplying credit to the industry/asset class start to relax their standards because they see a positive trend in place and they begin to impute it into their forecasts and behaviors. Competition heats up and if you insist on being a naysayer about the industry's prospects you lose market share and get left behind or fired. The industry grows and lots of newbies join, they have never seen a down cycle and all they see is naysayers getting left in the dust. Those who leverage up the most and take the most audacious bets....like buying real estate in Harlem in 1995 make the highest returns. These winners become very confident and they consume conspicuously.

FRAUDSTERS PILE ON/BIG BUSINESS PLAYS ALONG:

The money appears so easy to make that fraudsters start to get involved....I mean out and out larcenous criminals. Remember when the mafia got into starting penny stock bucket shops....you can't make this stuff up. During the dot com bubble a 15 year old boy named Jonathan Lebed bought penny stocks, then pumped them up using messages on chat boards, until he was busted by the SEC. Unfortunately, people who were otherwise honest in their careers, really don't want to or need to be criminals also become swept up in "institutional crime". This is the crime with no perpetrator....the mortgage company that invents a financial weapon of mass destruction because it can, it sells it to old retired ladies whose diabetes medicine cost increases are making their fixed retirement income tight and they end up refi'ing their way into oblivion. Some goober on Wall Street buys this paper because Moody's tells him its okay. His boss is watching his performance versus the other goober bond managers daily and if he dosn't buy this paper his competitor will and will beat him by taking more risk. Al Harrison, a well respected portfolio manager at one of the country's top mutual funds was buying Enron hand over fist, even after the CEO jumped ship.

NO ONE GETS OUT ALIVE:

The savviest market players start to talk about how hard it is to find good deals in the market, but when asked what they are doing they say BUYING. (Six months ago I went to a panel on commercial real estate....not residential....and heard the same thing. More on this in another post). In March of 2000 when the last spike of the tech stock bubble took place it was being widely circulated in the market that after sitting out the entire mania, the master himself George Soros was throwing in the towel and "buyin em".

THE FED RAISES RATES:

One day something happens and the market for the asset starts to soften - that thing is almost always - The Fed Raising Rates. You can cite overbuilding of fiber optics, OPEC violating quotas on oil pumping or anything else you like for asset price downturns, but all this overbuilding stuff can continue for long periods of time until The Fed Raises Rates. It's because stealthily firms are creating more and more credit to keep the asset rising, whether it be Cisco, Nortel and Lucent making loans to their customers Winstar and Level Three (anyone remember these names if you did you probably lost money in them) to buy their equipment or mortgage companies coming out with 10/1/10 Interest only Option ARM cash out refi leveraged reverse amortizing blow your head off loans.

SKINNY DIPPERS GET CAUGHT:

As the asset rolls over, the ripple effect of the tide going out starts. This is the part where you get to see "Whose Swimming Naked" and has hidden bets. It could be a hedge fund like Amaranth who was supposed to be diversified, but had a massive bet on Natural Gas prices so large regulators would have forbid it if they knew about it (but it was done through an online market outside their ken) or a European bank which was making big fees running an off-balance sheet conduit that borrows short, lends long and is leveraged....OUCH.

NO ONE WANTS TO GET CAUGHT HOLDING:

At this point in the cycle a crisis of confidence hits. Everyone knows that there are other players holding "The Old Maid" but they don't know how big or bad she is, or how many are out there. So they are very reluctant to even play the game. This is what happened in August folks, and when the gears stop turning the Fed steps in. The Fed can help grease the skids and eventually if needed they will bring out the big guns of liquidity if necessary, but they can't stop the inevitable unwinding of the asset and the damage to players. (FYI I totally agree with Noah there ain't no way they gonna cut rates with no data showing a slow down...and if they do...get worried.) In 1998, the Fed bailed out Long Term Capital to prevent the gears of financial commerce from grinding to a halt and the US did fine. But it didn't stop the destruction of wealth in foreign countries where the excesses were. I digress.

CLOSING THE BARN DOOR:

The last phase of the saga is the closing of the barn door. This happens of course when the horse is in the next county and wreaking havoc there. The great legislators of our country wake up to the fact that an asset bubble caused misbehavior intentional and unintentional and they create laws to protect the populous from this ever happening again. That's why bubbles move from market to market they stay away from areas people remember getting burned in before and areas where legislation impedes the bubble-ization process. Importantly, these laws make the pain in the asset worse and really put the nail in the coffin. Whereas before you could borrow to your heart's content to leverage an asset, the new rules significantly impede the ability to do this, making the asset less profitable to play in, so more people sell it. The related professions that were supposed to have some watchdog function in the industry that failed, like bond rating agencies and real estate appraisers get tarred as criminals. These professions which no one really understands but maybe has some distant relative who works in, become household names. These folks who were just doing their jobs become pariahs due to inherent conflicts of interest that had always existed in their jobs, but became problematic due to the bubble.

HATE CONQUERS ALL:

In past bubbles insurance agents, accounting firms and their consulting arms, Wall Street equity analysts and others have all taken the heat. Unfortunately, as a result these industry experts turn acutely conservative and become deal killers rather than deal enablers this makes dealing in the asset even harder and is the Coupe De Grace that makes the market hate the asset and avoid it until the next cycle begins.

I love data and I like to know The Numbahs. But in some cases you need to ignore the data, which is by nature backward looking and usually of only short-term import and just stand back and listen to what the crowd sounds like. History doesn't repeat itself but it rhymes. Re-read the bold phrases in this article and in addition to evaluating the data watch for these sign posts when you are assessing where you are in the cycle of any asset class.

HEMLINE INDICATOR COMEBACK?

Just a little epilogue. Indicators like the magazine cover indicator are obviously fallible they tend to correlate with tops and bottoms they don't cause them, but they give an indication of the psychology which is necessary at turning points. For many years fashion has been gyrating more feverishly than in decades past and has generally been on a trend of getting more risk-ay. As a result an old indicator called the hemline indicator stopped getting much play, despite being prescient to 1998's stock market shellacking. In eras gone by it was believed that when hemlines rose and fashion got more risky markets rose and that when hemlines became more conservative so did investors. The word out of Fashion Week hear in Manhattan....Look out below...the knee that is.

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Expect A Preventative Fed Rate Cut

A: Tough tough call here but something I must discuss as there is now statistical evidence that the US economy is slowing (read "Jobs Weaken Big Time...") amidst the turmoil in the credit markets. However, and its a BIG HOWEVER, there are still reasons NOT to cut rates that I will get into here. What will the fed do on September 18th, which will prove to be one of the biggest and most important fed meetings of 2007? I'm putting my bets on a 1/4 point rate cut, (25 basis points) PLUS another cut in the discount window, as preventative medicine to cushion the severity of any slowdown that is to come. Your thoughts?

First, let me explain why a fed rate cut will NOT necessarily mean a drastic reduction in lending rates! Right now, we are living in a new world. A world that is in the process of re-pricing risk as investors determine what type of risk demands higher premiums and what type of risk doesn't. In this new world, LENDING RISK is demanding higher premiums because quite simply it is filled with uncertainty and backed by a secondary market that is now illiquid and void of buyers. This is the simplest way for me to explain what is otherwise a very complex situation. For more in depth on this topic, read:

* How Mortgage Backed Securities Work
* Wells Fargo Rates Jump To 8% Overnight
* RMBS Markets Explained
* It's A Risky New World / Credit Spreads

Now, while lending risk is running under it's own set of guidelines, there has been a disconnect between the relationship it has with bond yields; specifically the 10YR bond yield. Recall in my AUGUST 4th post about the risky new world where I clearly stated:

Relating this to the mortgage markets, while short and medium term US gov't treasury yields are falling fast due to a flight to quality as stock prices fall, the rates on mortgage products are NOT falling at the same pace! This is because mortgage debt is now MORE RISKY than treasury bond notes and therefore demands a HIGHER RISK PREMIUM to gather investors; i.e. higher yields.

Take a look at the chart on the right which is not the most accurate for NYC lending rates but is good enough to prove the point I just made. Notice how the relationship between 10YR Bond Yields & 30YR Fixed up until the end of July (marked with two 'X's and a line on each chart where the disconnect begins) had similar movements. Then something happened! RISK! Subprime defaults hit wall street and the secondary mortgage markets ceased up. The resulting uncertainty hit stocks hard and caused bond yields to FALL (as investors fled to quality of US gov't treasury's), while the increased risk in mortgage markets ROSE (causing lenders to raise rates on loans, tighten standards, and limit options of loan products to consumers)!

Again, this is the simplest way for me to explain what is going on! So, in this new world what does the fed do? Well, there are two ways to think about it.

REASONS TO CUT RATES

* Inflation Moderating - Yea, but US metrics have been argued to be flawed. Commodity & Energy prices still very high. Inflation threats still persist. Arguments on both sides here.

* Prevent Recession - Cushioning move in monetary policy to help soften the hit when/if it comes

* Housing - Housing is still awful across much of the nation but we are yet to see a trickle effect in consumer spending. We are seeing effects in jobs now. Will fed be pro-active and cut ahead of the curve in anticipation of a slowdown in consumer spending as a result of housing downturn?

* Jobs Slowdown Three Months Now - Statistical evidence and the most compelling to warrant a rate cut. August jobs data was outright awful and the prior two months were revised down. This means the slowdown is in place already and fed is behind the curve.

REASONS NOT TO CUT RATES

* Moral Hazard - Fed bailout may prompt risky bets in future

* Weak US Dollar - Cutting rates will further weaken our currency? There are some arguments for the flip side though.

* Stocks Expect It & Priced In - Stock Indexes are only slightly off record highs as they priced in a rate cut. The fed should NOT give the markets what they want for fear they will selloff if they don't get what they want. In other words, the fed should NOT do what wall street expects. If we get no rate cut, we get a selloff!

* More Stimulus = More Inflation Risks - Cutting rates and pumping umph into the economic system could cause inflation to re-ignite down the road and energy prices to rise even further.

* Globalization Cushions Recession - Strong global economies could help cushion the downturn by itself. It may help corporate America, but the consumer is a whole new issue!

* Inflation Still A Risk - Sure, it is moderating at home, but how long will it last with oil at record highs and commodity prices still high! At some point will this re-ignite?

Cutting the fed funds target rate will NOT immediately turn around housing woes. It will NOT solve the illiquidity in credit markets and secondary mortgage markets. It will NOT solve problems with buyouts that fail to close. It will NOT solve the debt problems we have. It will NOT cause lending rates or the all-important LIBOR rate (to which adjustable mortgages/credit cards are tied to) to reverse course significantly!

You can see how tough a call this is for our fed and why this meeting is so important! The accompanying statement is just as important as the fed action is because it will tell us more what the fed is thinking in terms of future actions and their thoughts on the economy in general.

MY CALL - The fed will cut 1/4 point and bring fed funds target rate to 5%. Stocks will rally slightly as they really want a 1/2 point rate cut. I think the fed will also cut discount window again by 1/2 point to help liquidity in banking system a bit. If it's not 1/4 point, I'm betting on NO cut at all. The 1/2 point rate cut option is my least expected option. I would break it down like this:

60% CHANCE ---> 1/4 point cut
30% CHANCE ---> NO CUT
10% CHANCE ---> 1/2 point cut

Questions I have are how this will effect lending rates and the LIBOR rate, if at all. Since lending rates are operating under a different set of rules now, it's naive of us to think that past relationships between fed rate cuts and lending rates will prove true this time around!

YOUR THOUGHTS? WILL THE FED --->

1. CUT RATES 1/4 POINT
2. CUT RATES 1/2 POINT
3. NO CUT AT ALL

??????????????

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Why LIBOR Won't Hurt That Much

A: Great post by my friend Dan Green over at The Mortgage Reports about why the rising LIBOR rate won't hurt as much as the news media makes it out to be! The short answer is ADJUSTMENT CAPS that are tied to all adjustable rate mortgage holders. Lets discuss.

Mortgage Reports: Why LIBOR Will Not Impact Your Adjustable Rate Mortgage This Year

I have discussed the LIBOR rate here on UrbanDigs because so many resetting ARM's and credit debt is tied to this London rate! So, when that rate starts rising to 8 YR highs, it's hard not to notice and think ahead at the problems that may arise when debtors feel the pain of higher monthly payments! After all, this is what led to the current credit / liquidity squeeze in the mortgage markets and brought about tighter lending standards, higher rates, and fewer loan options (once subprime borrowers starting defaulting it hit the holders of the mortgage backed securities and wall street) in the first place. There is a reason I discuss this stuff!

Take a look at Dan's chart (for a buyer who took out a 3YR ARM in September of 2004 that is now resetting) that shows you what the all-important LIBOR rate has done since 2002, and note the 2.00% CAP that will kick in to protect holders of resetting ARM's and the zone above that which won't effect the debtor; assumes a 2% first year adjustment cap of course!

As Dan Green states:

The press is talking a lot about LIBOR right now and you may be getting nervous. There's no need to because most articles are leaving out the most important condition of an ARM's adjustment calculation -- the Adjustment Cap.

The Adjustment Cap defines the rate by which your mortgage can move up or down when annual (or semi-annual) adjustment is calculated.

Stated differently: Your mortgage rate doesn't just change willy-nilly -- it follows very clearly defined rules. Your rate cannot adjust too high too fast, or move too low too fast.

Question I have for the consumers out there is, what does it say in the fine print of your loan agreement about how much the cap is for both the first year adjustment and subsequent adjustments? Lets not forget that 2008 should be referred to as THE YEAR THE ARM's RESET! As I discussed previously, some $355B+ worth of home loans are set to adjust next year alone putting higher payments in the lap of many homeowners! Now, that certainly can't help us can it. But at least Dan brings up a great point, which is, it won't hurt as much as the media makes it out to be!

Which brings me to credit card holders of debt that is tied to LIBOR? These guys probably already noticed an increase and as far as I know, there is NO CAP on this! Lets be frank, America does have a debt problem and both mortgage debt and credit debt has been getting more costly to the holder of late! That means more money out of the pocket of the consumer that could be going towards spending, that is now going towards living.

If there just isn't enough money to pay this off, well then, the debtor becomes insolvent! An insolvency crisis has been brewing for some time and now that risk is causing the rates on loans and other debts to cost more, I worry that the game may end in a rough way down the road. What happens when these debts can't be paid off? What happens when the corporation can't raise enough money to pay its creditors? What happens when assets no longer exceed liabilities?

Who am I kidding? This is America! I'm sure someone will come up with an innovative way to keep the game going for a few more years!! And stocks will always go up and never ever ever go down! Ahhh what a dream it is!

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Homebuilder Offers 3-Day Fire Sale

A: What do you do when you are a major homebuilder with building inventory, weak buyer demand, pissed off shareholders, deals in contract going sour because loans aren't closing, and weak sales numbers? You cut your prices by 20% for the weekend of course! A trend perhaps?

The news via Marketwatch.com:

Home builder Hovnanian Enterprises Inc. (HOV: 11.00, +0.97, +9.7%) from Friday through Sunday is running a sales promotion featuring price incentives as high as $100,000 to attract buyers in a slumping housing market. The company said the event, which it is calling the "Deal of the Century," features a 72-hour sale at 31 neighborhoods around the country. Separately, Chief Executive Ara Hovnanian said the bottom of the housing market is "very near" but a recovery won't begin until 2009, according to a press report. "The bottom is very near but I think it's going to stay along the bottom for a while before a recovery," Bloomberg quoted Hovnanian, who said the builder hopes to sell 1,000 homes this weekend

The news of this major homebuilder taking action isn't shocking but the level certainly is! Certainly sucks for Hovananian customers who signed a contract over the past few weeks (play game over jingle from Pac-man now).

This to me signals a very bad quarter for the homebuilder who decided to make a longer term decision and take the short term loss that comes with it. A good move all around although a longer timeframe may have been warranted. The goal is to sell 1,000 homes this weekend in an attempt to get more deals done, get more revenue lined up, and to take away some building inventory. Just imagine what will happen if ALL of the major homebuilders decide to do a fire sale like this and appease to the buyers that have been waiting on the sidelines for a good deal! This certainly would peak my attention if I were one of the vultures flying around for scraps. How would that effect total inventory that has been building for so long? Great move by Hovnanian and I expect others to follow. The problem is the deal is only being felt in 31 neighborhoods across the country! I'd be very curious to see the results if they offered a similar deal to ALL of their markets!

Unfortunately, these homebuilders don't have a presence here in Manhattan and our marketplace is experiencing the opposite in fundamentals than most of the country with our tight inventory, foreign demand via the weak dollar, strong jobs market, low rental vacancy rates, and healthy buyer pool. I'm yet to see any real action by developers here by offering incentives to buyers other than what I read on Curbed.com the other day in their post "Signs of a Slowdown in New Development Deals".

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Lender's Checks For Taxes Bounce!

A: Crazy news and part of the insolvency concerns that I have been discussing lately. I read this from a commenter on one of Calculated Risk's posts today. Troubled lender American Home Mortgage apparently doesn't have enough funds to pay the real estate taxes for their mortgage clients! I seriously hope this is a trend that doesn't continue as it fits in nicely with the insolvency concerns Professor Nouriel Roubini has been discussing for some time and now has dragged me into his bandwagon.

The news story via Baltimore Sun's article "Ailing Lender's Checks Bounce":

Checks sent out by the troubled American Home Mortgage Investment Corp. to pay the property taxes of more than 70 homeowners in the Baltimore metropolitan area have bounced, local officials said yesterday.

"This is just another chapter in what is a very difficult time for the mortgage industry," said Donald I. Mohler III, a spokesman for Baltimore County, which no longer accepts checks from American Home Mortgage.

Homeowners often make monthly payments for property taxes, insurance and other fees to their mortgage companies to be set aside in escrow funds until the money is due.

Just to re-iterate that last line, usually the mortgage lender collects the estimated monthly real estate taxes that are due from the homeowner with their mortgage payment. The estimated monthly real estate tax payments are then placed into escrow accounts and then paid by the lender when due; usually quarterly. So what happens when a troubled lender co-mingles these funds for other corporate finance responsibilities and then can no longer pay? Hmmmmm, I wonder quietly to myself.

Professor Nouriel Roubini, who is not the most optimistic voice on the US economy, states in his "The Coming of the US Hard Landing" article (a very interesting read to say the least):

Today, in addition to severe liquidity problems in the financial system (a near total freezing of the entire financial system liquidity plumbing), we have serious credit and insolvency problems too. The credit and solvency problems derive from a massive credit boom that lead to excessive borrowing that, in turn fed for a while rising asset prices that are now going bust, in a typical Minsky credit cycle. It is a insolvency problem as you have now millions of US households that are near insolvent and will default on their mortgages; dozens of sub-prime mortgage lenders who have already gone bankrupt; dozen of home building companies that are under distress; many financial institutions in the US and abroad - such as hedge funds and other highly leveraged institutions - that have already gone belly up; and the rise in credit spreads will also lead soon to a rise in corporate defaults that had been artificially low in the last few years given the excessively easy credit conditions.

The Minskey Credit Cycle, as Professor Nouriel discusses often, is basically a model of asset bubbles that are driven by credit cycles; a cycle that obviously can be applied to our current environment after years of ultra cheap money and lax credit standards which led to a buyout and housing boom. My friend Jeff Bernstein also recently wrote about the psychology of asset cycles here on urbandigs (for all you that wonder why I discuss these macro economic topics and my thoughts, this news on American Home Mortgage and it hitting the consumers out there is the exact reason why)!

As I stated in my last macro update in the post "Jobs Weaken Big Time / Fed Likely To Cut" back on September 10th:

I have to adjust my biggest threats to housing once again as both my original predictions (tighter lending standards/credit crunch + jobs losses) have now come true. The two biggest threats to housing I now see are:

1. Global Growth Slowdown Amid Credit/Liquidity Crisis
2. Insolvency Crisis - Inability to pay back debts; assets no longer exceed liabilities

I'll discuss #2 when I get back to NYC. My biggest fear now is that a slowdown is here in the US economy and even worse, it will SPREAD TO GLOBAL ECONOMIES! Globalization has been such a major factor in the growth of US corporate profits and ultimately stocks for the past few years. If we remove that equation, we will be entering a period of stock market corrections, more layoffs, negative wealth effect, change in consumer psychology, and big cutbacks in bonuses and salaries. This has NOT happened yet! I often say this when I make these predictions as I did with my past ones.

Well the news out of American Home Mortgage on Friday could be signs of the beginning of that insolvency (assets no longer exceed liabilities; inability to pay debts) as a very real concern and that there are a number of classes that could be effected including the consumer, corporations, hedge funds, and any other highly leveraged entity.

In today's NY Post I read a troubling article titled "Consuming Fire" that stated:

Consumer spending - the jet fuel that supplies 70 percent of the economic activity in this country - is in danger of being choked off, the result of mounting credit card debt and falling house prices. "The last life preserver of home equity loans has just been ripped away, so families are now alone in a sea of debt," says Harvard Law School's Elizabeth Warren, a law professor and expert on consumer debt. She's referring to the ability of families to turn the rising value of their homes into home equity loans to pay off their fat credit card bills.

The Federal Reserve said last week that the amount of revolving debt, mostly on credit cards, held by American families grew by 21 percent, to $907.4 billion, over the past five years.

This far outpaces wage growth and was fueled by the ability to refinance mortgages and to grab home equity loans to pay off the debt.

But now, with housing prices falling, one key tool used to pay off the debt is blocked.

Along with this article came this graphic:

Do the math: Rising Credit Card Debt + Falling Home Prices + Declining Payment Rates + Higher Refinancing Rates + Fewer Lenders / Refi Options + Tighter Standards + Slowing US Jobs Market + Possible US Recession = ??????????

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UrbanDigs in NY Mag

A: Got some great press today and wanted to share the articles with you in NY Mag. There were two, but for this post I'll focus on the story about best & worst case scenario's hitting Manhattan real estate over the next few years.

Neigborhood Watch: How Vulnerable Are You? A Risk Analysis.

EAST VILLAGE & LOWER EAST SIDE: These neighborhoods are no longer "emerging" - they have emerged, and we are not going back to dodging crack dealers on Avenue A. That said, a big market swing could certainly hit here, because these areas are still most attractive to the young, and young buyers can be fearless.

"They take more chances and they're more aggressive, the kind of people who put more of their assets into living where they want to live," says Citi Habitats agent Noah Rosenblatt, a former Wall Street trader who now blogs about the market on Urbandigs .com. "They haven't seen a major crash and don't know that they may get salary restrictions or that their bonuses may not go up as much. No good time lasts forever"

Real Estate Report 2007

A look into what the best case and worst case scenarios might be from the minds of Professor Ed Glaeser, Brad Inman, Professor Nouriel Roubini, Tim Harford, Professor Tyler Cowen, and yours truly! I am honored to be considered in the same group as these guys, let alone have the opportunity to speak my opinion on such an exciting topic!

The article is a great read and incorporates the thoughts of all the above mentioned names. It doesn't give specific predictions by each person though, so for those that are interested in what I thought and submitted, here are some excerpts copied exactly from what I handed in:

WORST CASE SCENARIO

2008 - Consumer spending & Labor market will weaken as the economy enters a recession towards years end and into early 2008. Fed cuts rates to cushion the blow but that won't help lending rates that much as the re-pricing of risk and drying up of secondary mortgage markets result in a disconnect between falling bond yields and lending rates. Re-pricing of risk is evident in the rising LIBOR rate to highest level in 8 ½ years, even as bond yields fall, which results in serious pain for debtors; especially for those with resetting adjustable rate mortgages (ARM's) and with credit debt tied to this rate. This becomes third leg in nationwide housing downturn and starts to hit Manhattan at a lag. Tightening of lending underwriting standards and rising rates on Jumbo loans hit affordability & buyer psychology which reduces size of the qualified buyer pool. Buy side demand weakens.

Correction: 3-5% as fundamental shift takes time to work through; pockets of distress experience 5-7% downside risk

2009 - Insolvency crisis may reveal itself as consumer/corporate debt can't be paid off. Democrats take over and alter tax friendly laws effecting wall street. Any further correction in stocks as a result will contribute to a deeper negative wealth effect and deteriorating psychology amongst buyers. Again, bonuses are hit and jobs as well. Labor market woes reduce buyer pool further. Credit crunch continues to limit availability of leveraging and affordability. Rental prices come down at a lag to stock declines.

Correction: 4-6%; correction tends to be faster once fundamentals reverse course and favor downside.

2010 - Not worried about new mayor. Changes already in place for 421A tax abatement for developers so any further change is likely to reverse these changes to re-instate tax friendly programs to encourage development. After effects to US economy from the 2007-2008 liquidity/credit squeeze still being felt in wall street and main street. Consumer psychology still effected as conservatism sets in. Unless inventory trends completely reverse course, any correction into 2010 is likely to begin triggering demand on buy side from those waiting on the sidelines; especially from longer term investors and those that survived the downturn in the economy unscathed.

Correction: 1-2% as buying gets more attractive to those waiting for downturn.

BEST CASE SCENARIO

2008 - Liquidity squeeze proves to be short lived. The bad bets were weeded out, corporations and hedge funds book their bad assets to market and take tax friendly loss, restructuring takes place and transparency returns to free markets. Global growth continues and is evident by lagging inflation and high commodity prices; necessary side effects of strong growth. Fed maintains rates as there is no need to pump liquidity into financial system to help cushion blow to US economy. Wall Street cheers the return of certainty with continuing gains. Wealth effect in place and little ultimate effect on jobs, bonuses, and salaries here in NYC. As a result, fundamentals powering Manhattan real estate for past 3-4 years remain intact. Inventory stays tight as demand never wanes.

Appreciation: 3-4%

2009 - Insolvency crisis proves to be under control; assistance for debtors from gov't or outside agency? Temporary higher rates (2007-2008) for debtors prove to be absorbed by strong jobs market and US economy. Lending rates start to return to normal association with bond market and specifically 10YR yields; predictability returns and volatility is low again. Lenders gain confidence in housing's future nationwide and as a result, tighter lending standards that have been in place for past year and half are loosened a bit; but not anywhere near as loose as they used to be. Manhattan remains a desirable place to live and the trend of living closer to workplace strengthens further. Inventory has no chance to reverse course from any economic slowdown, rental inventory remains tight and expensive, and buyers still compete for well priced properties. Should Dems win presidency, they maintain current tax laws for capital gains/carried interest and wall street applauds with continued gains and interest from hedge funds.

Appreciation: 3-4%

2010 - Global growth experiences NO slowdown after years of worry. With globalization comes a more consistent and resilient US economy; and therefore stock market. Bull run is sustainable, but with pockets of healthy 2-3 month corrections here and there. Jobs, bonuses, salaries here in NYC (specifically in financial sector) remain intact continuing to power the sustainable boom in local housing. Fed maintains fed funds rate in the 5-6% range even as global growth, inflation, and high commodity prices still exist. As long as we are below 6% in fed funds target, I don't see it being restrictive to future economic growth potential.

Appreciation: 3-5%

You can read the full article here and compare what I said with what the group consensus was.

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Big Fed Day: Rate Cut Likely But...

A: Ben Bernanke and Co. will decide at 2:15 EDT today what their course of action will be, if any, for monetary policy that affects the overnight lending rate banks charge each other and which sets the tone for either restrictive or stimulative policy towards the US economy. In my opinion, the stock market has already priced in a 1/4 point rate cut and future cuts into equity prices and will ultimately selloff when they don't get as aggressive a move or statement when the fed releases their decision later today. Here's why.

Here are the main reasons why the fed will only cut by a 1/4 point, if at all, and not release as aggressive a statement in regards to future rate cuts:

Inflation Risks - Oil is at record highs, Gold is over $700/ounce, and other commodities are at highly elevated levels keeping longer term inflation risks from dissolving. Alan Greenspan even went on record recently as stating that long term inflation remains a very real concern and that he worries about double digit fed funds rates at some point down the road. The fed is still stuck between a rock and a hard place and can't risk aggressively lowering the fed funds rate and pumping too much liquidity/stimulus into US economic systems and ultimately making long term inflation risks even worse.

Weak US Dollar - The US dollar will gain some strength against European currencies if the credit mess hits over there and the ECB sees a need to stop raising rates, reverse course and actually lower rates. But that is yet to be seen. The credit crunch hitting Northern Rock in the UK has told us that Europe is not immune to current risks and that they may be next. As far as strength in any currency, there will be little if the overall economy gets hit; a strong economy yields a strong currency. We know that the US dollar has been super weak and I just don't see how our fed could start to embark on a aggressive rate easing campaign, further weakening our currency. Our currency could see gains on other currencies though IF this credit contagion ends up hitting global economies which will cause central banks to lower rates and global currencies to give up some gains against the US dollar. It seems we were first in this mess and could be first out of it too.

Stocks Still Near Record Highs - Major stock indexes are only 5-6% off record highs. Does this sound like an environment ripe for major rate cuts to you? If there were no chance of a fed rate cut, stock indexes would probably be 2-3% lower! There is already a premium priced into stocks for today's expected rate cut.

Avoid Recent History - One major reason we are in this credit mess (which is the main reason for US recession fears right now) is because of ultra cheap money and Greenspan's aggressive action on monetary policy bringing the fed funds rate down to 1%, keeping them there for too long, and not raising them back up aggressively enough (2 years of 1/4 point rate hikes is as slow a course of action as you can get). How could Bernanke and Co. ignore the risks of recent history repeating itself by aggressively lowering fed funds rate again; they can't and won't!

There are also real reasons for the fed to take action knowing that any fed move today will not effect the overall economy for a good 8-12 months. A few of these reasons include the very weak jobs report that came out a few Friday's ago, the nation wide housing problem, illiquidity in credit markets (which a cut in discount window can help a bit), and expected side effects to US economy and consumer spending. Some argue the fed is already behind the curve and about 2-3 rate cuts too late, while others argue that inflation fears are far too real to warrant any move in the fed funds rate. Very tough position for Ben Bernanke and his colleagues.

Here is my call. The fed will:

1. Cut Fed Funds Target Rate 1/4 Point (25 basis points)
2. Cut Discount Window 1/2 Point (50 basis points)
3. Issue a more conservative statement than most expect and mention they will be 'ready to act' as needed and determined by incoming data. Mention that inflation risks still remain in some way, shape or form.

I think the stock markets will ultimately selloff on the move after pricing in this action already. I do NOT think the fed is about to embark on a long term rate easing campaign! I think they will cut rates by a total of 50-75 basis points at most, bringing the fed funds target rate down to 4.5% or so, as a preventative measure to cushion any economic slowdown that does result from the credit/liquidity crunch. Not only that, but it is very likely that we won't stay at those levels for long, as inflation risks will force the fed to raise rates more aggressively down the road (a longer term view of fed funds target rate).

If I'm wrong, and the fed doesn't cut the target rate today by 1/4 point, I think the move will be NO CUT AT ALL! I think those expecting a 1/2 point rate cut are way off, and I will be very surprised and worried if that happens. Here is what to expect for all scenarios and my percentage bet for each:

65%: Fed Cuts Target Rate 1/4 Point + Discount Window Cut ---> Initial jump in stocks and then selloff
30%: Fed Doesn't Cut Target Rate + Discount Window Cut ---> Stocks selloff
5%: Fed Cuts Target Rate 1/2 Point + Discount Window Cut ---> Stocks rally

All in all, a very important day to see where our monetary setting body stands right now and for future moves that may be in the works.

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Fed Acts! Cuts By 1/2 Point!

A: The fed decided to GO VERY AGGRESSIVE and cut the target rate by 1/2 point PLUS the discount window by 1/2 point! Holy cow! Quite a surprise and stocks are obviously rallying big time on this news! With such a move, I question how bad this credit mess really is on effecting the US economy and continuing the housing downturn!

Wow! This was my least likely of options as we all learned a bit about Ben Bernanke today! Here