Some thoughts on Bernanke and the FHA bailout plan

So now we've had some time to read the speech from Fed Chairman Ben Bernanke, as well as review the official announcement of the "FHASecure" plan. There are a lot of details to sort out, and we'll learn a lot more about the potential impact of FHA reform on the mortgage industry over time. My sense, though, is that policymakers and politicians are going to have to do a lot more if they want to ameliorate the pain from the housing and mortgage bust.

The reason: The underlying market is still in very bad shape. Existing home sales have dropped about 20% from their peak. New home sales have declined 37%. The inventory of existing homes for sale hit a record high of 4.59 million units in July, and new home inventory is also sky high.

Median home prices, as measured by the National Association of Realtors, have dropped from year-ago levels for a record 12 months in a row. Separately, research firms S&P and Case-Shiller say prices dropped 3.2% in the second quarter, the biggest decline since they started collecting data in 1987. A home builder optimism index just fell to its lowest level since 1991, and a measure of home construction activity just hit to a 10-year low.

In other words, it won't be easy to "solve" the housing problem. This paper (warning: large PDF link) should help shed more light on my views of the market and potential reforms.

Lots of chatter about President's mortgage plan

I thought -- heck, just about everyone thought -- that Fed Chairman Ben Bernanke's speech at 10 a.m. EST was going to be the big news of the day in mortgage-land. But overnight, some details of a plan by President Bush to help bail out subprime borrowers were leaked to the press. According to various reports (from the New York Times, USA Today, Washington Post, and more) ...

* The plan will change the way the Federal Housing Administration (FHA) loan program works. It "would let an additional 80,000 homeowners with spotty credit records sign up, beyond the 160,000 likely to use it this year and next," per the Times. Specifically, according to the Post, FHA guidelines will be modified so that borrowers with ARMs who have fallen behind on their payments due to a rise in rates can refinance into FHA loans. Currently, guidelines prohibit borrowers who are already delinquent on their current mortgages from refinancing into FHA loans.

* Lenders will be pressured to avoid foreclosing on some borrowers.

* FHA credit guidelines will reportedly be eased, though those loans will require higher FHA insurance premiums. The 3% equity requirement FHA currently has may be eased as well, though it's not clear exactly how from the reporting out there.

* FHA loan limits will likely be raised, which would allow larger-denomination mortgages to be made. The Post says it will go from $362,000 in expensive-housing states to $417,000, the current cap on conforming, Fannie Mae and Freddie Mac loans.

* Legislation will be encouraged to deal with the "debt forgiveness" tax burden. Currently, if your mortgage lender waives a portion of the money you owe, the IRS generally considers that "income" and taxes it. For instance, if you buy a $200,000 house with a $200,000 mortgage, and its value falls, you might negotiate a short sale with the lender. You'd sell it for $180,000 and the lender would forgive the $20,000 difference ... but the IRS might tax that $20,000 as if it were income.

Full details won't come until later this morning. I'll try to update the blog later today.

OFHEO home price index data out ...

There are plenty of ways to measure what home prices are doing. One of the most widely followed reports is the one from the Office of Federal Housing Enterprise Oversight -- OFHEO. The Q2 figures just came out (warning: Large PDF file). They show ...

* Home prices were UP 3.19% from a year ago. That's down from a 4.45% gain in Q1 2007 and a 9.98% gain in Q2 2006. Moreover, it's the smallest gain since Q2 1997, when prices rose 3%.

* On a quarter-over-quarter basis, prices were up 0.08%. That's down from a 0.55% gain in Q1 2007 and a 1.3% gain in Q2 2006. It's also the worst reading since Q4 1994, when prices dipped 0.23%.

* By state, Utah showed the fastest rate of appreciation over the past year at +15.28%. Wyoming (+12.84%) and Washington (+9.12%) were next in line. Five states showed price declines -- Rhode Island (-0.97%), Massachusetts (-0.99%), California (-1.38%), Michigan (-1.42%), and Nevada (-1.45%)

* By city, Wenatchee, WA was the appreciation winner (+23.54%), with Provo-Orem, UT (+18.21%) and Salt Lake City, UT (+16.03%) close behind. The weakest links? Merced, CA (-8.65%), Santa Barbara-Santa Maria-Goleta, CA (-8.1%) and Stockton, CA (-7.2%). A total of 61 out of 287 metro areas showed price declines. That's 21.3% of the sample. In Q1 2007, 46 of 285 cities showed declines -- 16.1%. In other words, price declines are becoming more widespread.

Sadly, my own metro (West Palm Beach-Boca Raton-Boynton Beach, FL) ranked 272nd on the list, with a 1-year decline of 4.51%. I don't think they give out ribbons for that kind of performance.

Some early morning headlines and thoughts

There are lots of juicy news items to cover this morning, so let's get right to 'em...

* Bloomberg has a story headlined "Bernanke May Hear Call for Fed Activism on Assets, Regulation." The gist of it? That the Fed's laissez-faire attitude toward regulation ... and its stark refusal to target inflating asset bubbles by raising interest rates ... is flawed and needs correcting. I couldn't agree more. The Fed has a ridiculous double standard -- it says it can't detect inflating asset bubbles and should therefore not target them with interest rates ... but it claims it can decide when a bubble has burst, and should respond by lowering rates to "clean up the mess."

* Another hedge fund has been hammered by the subprime mortgage rout. Basis Capital Fund Management of Australia said its second-largest hedge fund filed for bankruptcy. Called "Basis Yield Alpha Fund," it may have lost more than 80%, according to Bloomberg. Oops.

* H&R Block just reported that Q1 losses more than doubled due to costs related to its subprime mortgage unit, Option One Mortgage. It has been trying to unload the division to Cerberus Capital Management, and is now renegotiating the terms of that proposed sale. The company's CEO had some choice words for conditions in the mortgage market. According to some Bloomberg headlines, things are the "worst since 1930." He added that loan originations at Option One have plunged from about $1 billion a month to just $200 million.

* Meanwhile, in the money markets, LIBOR rates are climbing again amid a general game of "Who's holding the bag?" on subprime losses. Another contributing factor: The Bank of England reported that it loaned out $3.2 billion at its 6.75% penalty interest rate. We don't know who borrowed the money from the BOE's lending unit, which is somewhat similar to our Fed "discount window" here in the U.S. But that was the largest loan made since July 2.

Above is a chart of U.S. dollar-based 1-month LIBOR. You can see that we're setting a new high for this up cycle today. By the way, if you want to learn more about LIBOR, what it is, and how the British Bankers' Association calculates it, check out this link.

Give me 2-year notes or give me death!

Okay, so I'm butchering the famous Patrick Henry quotation from 1775. But I think it definitely applies to the sentiment of buyers in today's auction of 2-year Treasury Notes. Uncle Sam sold $18 billion of said notes today. The bid to cover ratio, which measures the volume of bids submitted versus the amount of notes sold, was a whopping 3.97. That's up from 2.59 at the July 25 auction and the highest going back several years (Bloomberg says it's the highest since at least September 1992, Tony Crescenzi at Realmoney.com says it's the highest since at least 1989). The notes were also sold at a yield of 4.115%, below pre-auction forecasts of 4.155%.

What's it mean? That investors are still clamoring for safe investments rather than risky bonds. Central bankers the world over have thrown tens of billions of dollars at the market in an attempt to re-liquify things and restore normalcy to the non-government bond market. But so far, it looks like people still want their T-bills and T-notes.

There goes that pesky volatility again

Several days ago, I talked about how we've seen several volatility spikes in recent weeks -- each followed by a higher low. My verdict: That could make bottom fishing and bottom calling a dangerous game. Today, the Dow got pounded. And sure enough, it looks like we MAY have made another higher low. The question now, of course, is whether we'll see VXO 35 again. Enquiring minds want to know.

The Fed on housing ...

Minutes from the Federal Open Market Committee meeting on August 7 were released this afternoon. There isn't much surprising in the minutes given what we've all seen on our trading screens. For instance, the minutes said: "Financial market conditions were volatile during the intermeeting period, particularly over the last few weeks of the interval." Dare I say "Duh"?

What stands out to me the most? The Fed seems a lot more bearish on the housing outlook. Does this mean our blissful state of "well-contain-ed-ness" is threatened? Anyway, here are some excerpts worth noting ...

--> "Demand for housing in the second quarter was restrained by higher interest rates and by tightening credit conditions in the subprime mortgage market. Sales of new and existing homes in the second quarter were down substantially from their average levels in the second half of 2006. In June, single-family housing starts held steady at their May rate, although adjusted permit issuance slipped further. The combination of decreased sales and unchanged production left inventories of new homes for sale still elevated. House-price appreciation continued to slow, with some measures again showing declines in home values."

--> "Mortgage loans and consumer credit appeared to remain readily available to households with strong balance sheets, although late in the period some evidence pointed to diminishing availability of jumbo mortgages" ... "Growth of home mortgage debt likely slowed again in the second quarter, mainly reflecting the decline in home-price appreciation over the past year and the drop in home sales."

--> "Participants agreed that the housing sector was apt to remain a drag on growth for some time and represented a significant downside risk to the economic outlook. Indeed, developments in mortgage markets during the intermeeting period suggested that the adjustment in the housing sector could well prove to be both deeper and more prolonged than had seemed likely earlier this year. Participants noted that investors had become much more uncertain about the likely future cash flows from subprime and certain other nontraditional mortgages, and thus about the valuation of securities backed by such mortgages. Consequently, the markets for securities backed by subprime and other non-traditional mortgages had become illiquid, and originations of new subprime mortgages had dropped sharply. While these markets were expected to recover over time, it was anticipated that credit standards for these types of mortgages would be tighter, and interest rates higher relative to rates on conforming mortgages, in the future than in recent years. However, participants also observed that mortgage loans remained readily available to most potential borrowers, and that interest rates on conforming, conventional mortgage loans had declined in recent weeks, providing some support to the housing sector."

--> "Several participants noted the risks that house prices could decline significantly and that credit standards for home equity loans could be tightened substantially as factors that could weigh on consumer spending."

--> "The ongoing adjustment in housing markets likely would exert a restraining influence on overall growth for several more quarters and remained a key source of uncertainty about the outlook."

June S&P/Case-Shiller home price index: DOWN 3.49% YOY

Every month, S&P and Case-Shiller release data on home prices. They have indices that track what home prices are doing in major cities around the country. The group's 20-city index showed ...

* Home prices fell 0.39% between May and June. That was up from a 0.27% fall in May and the sharpest one-month decline since January (when prices slipped 0.5%).

* On a year-over-year basis, home prices fell by 3.49% in June. That was a sharper decline than the 2.88% fall we saw in May. It is also the worst reading yet in this down cycle.

* Of the 20 cities in the composite index, 15 out of 20 showed a YOY price drop (the same as in May). Detroit showed the sharpest decline (-11.01%), followed by Tampa (-7.7%), San Diego (-7.3%), and Washington, D.C. (-6.96%). The country's strongest upside performer was Seattle (+7.94%). Next in line were the cities of Charlotte (+6.78%) and Portland (+4.52%).

* A separate quarterly index showed a 3.2% decline in the second quarter, the sharpest decline on record (this data series goes back to 1987).

Like I said yesterday, it really is a supply story in the housing market. We have way too many homes for sale given the current level of demand. Just take a look at this chart. It shows a 25-year history of existing, single-family home, for-sale inventory.

As of July, there were 3.85 million units on the market. That compares with an average of around 2.2 million units during the reference period and a previous peak of 3.04 million units in April 1986. Is it any wonder home prices are slumping?

July Existing Home Sales ...

At the end of last week, we got data on the new home market in July. Sales rose modestly, while inventory for sale slipped. Now, we have the rest of the picture -- July existing home sales data from the National Association of Realtors. Here's a breakdown of the numbers:

* Sales fell 0.2% to a seasonally adjusted annual rate of 5.75 million from a revised 5.76 million SAAR in June (previously reported as 5.75 million). That was just a smidge better than economists' forecasts of a 0.9% decline to 5.7 million. July sales were down 9% from 6.32 million a year earlier, leaving them at the lowest level since November 2002.

* For sale inventory came in at 4.592 million single-family homes, condos, and co-ops. That was up 5.1% from 4.368 million in June (previously reported as 4.196 million units), and up 18.9% from 3.861 million in July 2006. It's also the highest level on record. On a months supply at current sales pace basis, inventory was 9.6 months, up from 9.1 months in June (previously reported as 8.8) and up from 7.3 a year earlier.

We have a longer history of months' supply figures in the single-family only market. Using that reading (9.2 months), we're the most oversupplied since October 1991.

* Median prices inched lower to $228,900 in July from $229,200 in June. June's figure was previously reported as $230,100. On a year-over-year basis, prices were down 0.6% from $230,200 in July 2006. Thanks to the revision to last month's data, we have now seen a record 12 months of YOY home price declines.

Forget "location, location, location." The most important factor in today's real estate market is "supply, supply, supply." We are literally swimming in an ocean of homes for sale. In fact, at 4.59 million units, we have the most raw inventory for sale in history. We're also at a cycle high of 9.6 months supply at the current sales pace.

Until we work through this extremely large inventory glut, we're not going to see any momentum in home prices. In fact, they fell for the 12th month in a row on a year-over-year basis in July. One other thing to keep in mind: These are "PC" figures -- Pre-Crunch. The mortgage credit crunch that began very late in July and picked up steam in August will likely put more downward pressure on home sales and prices this month and into the fall.

July New Home Sales were a pleasant surprise, but ...

This month, new home sales stats are coming out first. Here's what the July numbers showed:

* Sales rose 2.8% to a seasonally adjusted annual rate of 870,000 from a revised 846,000 SAAR in June (previously reported as 834,000). That was better than economists' forecasts for a 1.7% decline to 820,000. On a year-over-year basis, July sales were down 10.2% from 969,000 in July 2006.

* For-sale inventory came in at 533,000 new homes. That was down slightly from 538,000 in June (previously reported as 537,000) and down 7% from 573,000 in July 2006. On a months supply at current sales pace basis, inventory was 7.5 months, down from 7.7 in June (previously reported as 7.8), but up slightly from 7.4 a year earlier.

* Median prices rose 3.9% to $239,500 in July from $230,600 in June (previously reported as $237,900). Prices were up 0.6% from $238,100 in July 2006.

It's not very often we get good news on housing. But the July new home sales figures were a pleasant surprise. Sales rose (vs. forecasts for a decline), while for-sale inventory dipped and prices bounced.

What's not to like? Glad you asked. These numbers are "pre-crunch." We all know the mortgage market began melting down at the end of July and into August. So future home sales numbers will look worse ... potentially much worse. Census figures also fail to capture the impact of order cancellations -- when a previously contracted buyer backs away, the data is not adjusted for that. Since the major home builders are reporting cancellation rates in the 20% - 40% range, ACTUAL, closed home sales are lower than what is being reported.

So feel free to throw a handful of confetti in the air. But keep those mourning dresses and dark suits handy -- because the August and September data might be more fit for a funeral.

The confidence game

I'm out of the office for some R&R the next couple of days. But I can never totally pull myself away from the markets -- not with all this volatility. The latest development worth mentioning on the mortgage front, of course, is the news that Bank of America invested $2 billion in Countrywide Financial by purchasing non-voting preferred stock.

Bank of America's comment on the move:

"In the current turmoil, the stock market has been underestimating the value in Countrywide's operations and assets," Bank of America Chief Executive Kenneth Lewis said in a statement. "We hope this investment will be a step toward a return to more normal liquidity in the mortgage markets."

Clearly, the government and the major banks are doing a full-court press to restore confidence in the financial system. It seems like every other day, Treasury Secretary Henry Paulson is on TV talking about how great the underlying economy is. And of course, four major financial institutions slid up to the Fed's discount window to borrow $2 billion yesterday in an attempt to erase the stigma of such borrowings.

That's all well and good. But no amount of PR can change the fact the underlying fundamentals are deteriorating rapidly in the banking industry, thanks to the mortgage and housing bust. So the jury is definitely still out on whether or not this novel approach to confidence-building will work. It certainly is working in the short-term by boosting stock futures.

More mortgage problems ...

Blogger was offline earlier today, so a post I put up on some of the latest mortgage developments got lost somewhere in electronic Never Never Land. Let me try to recap some of what I meant to say ...

1) The Mortgage Bankers Association's purchase mortgage applications index fell 23.4 points in the week ended August 17 to 441.5 from 464.9. That’s a 5.03% drop, the largest decline (on a percentage basis) since the week of January 19. The refinance index fell 123.3 points to 1806.3 from 1929.6, a decline of 6.39%. That’s the sharpest decline for refi activity since the week of May 25.

My take: These figures probably reflect growing disillusionment with the mortgage and housing markets. Consumers see the news. They see that home sales are slumping and that lenders are rejecting more applicants. So they’re moving to the sidelines. Longer-term, we’ll probably see even more pressure on the housing market. After all, some lenders are failing, while others are tightening their lending standards.

2) H&R Block tapped $850 million in credit lines to finance its Block Financial business. It did so because the turmoil in the commercial paper market prevented it from obtaining financing on decent terms there.

3) Accredited Home Lenders is closing 60 retail branches, five support centers, and no longer accepting U.S. mortgage applications in its wholesale lending arm (which makes loans through third-party brokers). It is also slashing 1,600 jobs. HSBC is also pulling back from its subprime mortgage business. It said it would close an Indiana loan servicing office and let 600 workers go.

UPDATE: Subprime lender Delta Financial is now on the tape saying it's eliminating 300 jobs, or about 20% of its workforce. It is closing offices in Florida, Texas and California as part of the move.

UPDATE2: Lehman Brothers is shutting down its BNC Mortgage division and jettisoning 1,200 employees. The unit originated about $14 billion in subprime mortgages last year.

Q2 banking stats out ... and they don't look good

The FDIC just released data on the banking industry for Q2 2007. Suffice it to say the numbers don't look good. You can read the full "Quarterly Banking Profile" document at this PDF link. But let me excerpt some of the main points, highlight a few things in bold, and then comment on them ...

EXCERPTS:
* There were 824 institutions reporting net losses for the quarter, compared to 600 unprofitable institutions a year earlier. This is the largest year-over-year increase in unprofitable institutions since the third quarter of 1996. The increase in unprofitable institutions was greatest among institutions with less than $1 billion in assets, and among institutions with high levels of residential real estate and commercial loan exposures. The proportion of unprofitable institutions — 9.6 percent of all insured institutions — was the highest level for a second quarter since 1991.

* Insured institutions added $11.4 billion in provisions for loan losses to their reserves during the second quarter, the largest quarterly loss provision for the industry since the fourth quarter of 2002. This was $4.9 billion (75.3 percent) more than they set aside in the second quarter of 2006.

* Net charge-offs totaled $9.2 billion in the second quarter, the highest quarterly total since the fourth quarter of 2005, and $3.1 billion (51.2 percent) more than in the second quarter of 2006. The loan categories with the largest increases in net charge-offs included consumer loans other than credit cards (up $757 million, or 60.9 percent), commercial and industrial (C&I) loans (up $577 million, or 71.4 percent), residential mortgage loans (up $422 million, or 144.3 percent), and credit card loans (up $393 million, or 12.1 percent). All of the major loan categories posted both increased net charge-offs and higher net charge-off rates.

* The amount of loans and leases that were noncurrent (loans 90 days or more past due or in nonaccrual status) grew by $6.4 billion (10.6 percent) during the quarter. This is the largest quarterly increase in noncurrent loans since the fourth quarter of 1990, and marks the fifth consecutive quarter that the industry’s inventory of noncurrent loans has grown. Almost half of the increase (48.1 percent) consisted of residential mortgage loans. Noncurrent mortgages increased by $3.1 billion (12.6 percent) during the quarter. Real estate construction and development loans accounted for more than a third (34.2 percent) of the increase in noncurrent loans. Noncurrent construction loans increased by $2.2 billion (39.5 percent) during the quarter. The amount of home equity lines of credit that were noncurrent increased by $407 million (16.6 percent) during the quarter. The industry’s noncurrent loan rate, which was at an alltime low of 0.70 percent at the end of the second quarter of 2006, rose from 0.83 percent to 0.90 percent during the second quarter. This is the highest noncurrent rate for the industry in three years.

* Banks and thrifts grew their loss reserves by $2.6 billion (3.2 percent) during the quarter, as loss provisions of $11.4 billion surpassed net charge-offs of $9.2 billion. The $2.6-billion rise in loss reserves was the largest quarterly increase since the first quarter of 2002, but it barely kept pace with growth in the industry’s loans and leases. The ratio of reserves to total loans increased from 1.08 percent to 1.09 percent during the quarter, but remains near the 32-year low of 1.07 percent reached at the end of 2006. For the fifth quarter in a row, reserves failed to keep pace with the increase in noncurrent loans. As a result, the industry’s "coverage ratio" of reserves to noncurrent loans fell from $1.30 in reserves for every $1.00 of noncurrent loans to $1.21 during the quarter. This is the lowest level for the coverage ratio since the third quarter of 2002. Reserves increased at 60 percent of institutions during the quarter.

MY COMMENTS:
The FDIC’s latest figures show a banking industry that’s clearly suffering from the housing and mortgage slump. We’re seeing charge-offs, loan loss provisions, and noncurrent loans all rise sharply. That’s likely to continue as long as home sales remain weak and home prices continue to slump.

There’s plenty of turmoil in the non-bank mortgage market, too. Many lenders are failing, while others are tightening their lending standards. In just the past few days, for instance, Capital One announced it would wind down its GreenPoint Mortgage unit and First Magnus Financial filed for bankruptcy. Combined, the two lenders originated around $66 billion in mortgages last year. American home Mortgage, a $59 billion lender in 2006, also recently went broke. That doesn’t bode well for housing demand.

The key question for the health of the banking industry going forward is, "What happens to the economy outside of housing?" We have dodged recession so far. But layoffs are rising fast. The financial sector alone has announced about 88,000 job cuts this year, 75% more than in 2006, according to Challenger, Gray & Christmas. If we see cutbacks spread to other industries, and consumer spending slip, the economy will slump further. That would cause credit quality to deteriorate in other loan categories. And that would lead to more earnings hits, more loan losses, and potential bank failures down the road.

Noodling about volatility and market bottoms

Throughout this down move in the markets, we've heard repeated proclamations that "the worst is over" ... "the bottom is in" ... etc., etc. The latest assumption is that the Fed's discount rate cut will save the day (because rate cuts clearly worked so well in 2001, I suppose).

Anyway, I have also seen many options players cite the fact that volatility is spiking. They maintain that these spikes are bullish because they represent panic moves. But take a look at this chart of the CBOE OEX Volatility Index, or VXO. Every single volatility spike to date has been followed by a higher low -- and an even HIGHER spike thereafter. You saw a similar pattern in past crises, such as the Long-Term Capital Management meltdown in 1998. In fact, from July 20, 1998 through October of that year, I count 9 separate new "spike" highs in the VXO (including the ultimate intraday spike to 60.63 on 10/8/98).

At some point, we'll record a legitimate, major spike, followed by a legitimate reversal that leads to a lower low in volatility indices like the VXO. But until that happens, calling a bottom seems a bit dangerous to me.

Fed's Lacker dampens bailout talk, downgrades housing assessment

Richmond Fed president Jeffrey Lacker is on the tape with some comments that appear to dampen the speculation about an imminent cut in the federal funds rate. The general gist of his remarks? That the Fed can do other things (like cut the discount rate or flood the banking system with excess reserves) to ensure short-term liquidity, while keeping the longer-term federal funds rate target stable, assuming conditions in the "real" economy remain stable.

Meanwhile, he is downgrading his assessment of the housing market. The key passage:

"Even before the recent stint of financial market turbulence, the predominant concern on the real side of the economy was the outlook for housing activity. Residential investment fell rapidly over the last three quarters of 2006, but then the rate of decline slowed in the first half of this year. The question in my mind a couple of months ago concerned whether home-building would bottom out soon or continue declining. Recent data on actual housing market activity have dampened my optimism, however. Housing starts and residential building permits, which earlier this year looked as if they might be stabilizing, have both softened in the last couple of months. Broader measures of sales activity are also showing a pronounced downward trend.

"While the housing market implications of the recent financial market turmoil are quite unclear at this stage, there is a possibility that it will result in further increases in retail mortgage rates for some borrower classes and thus further dampen residential investment. Mortgage rate spreads have risen substantially for subprime borrowers, as one would expect given what has transpired, and for any borrowers with low down payments and low documentation. In the last few weeks, rates have moved up for jumbo mortgages as well. It is not yet clear, however, to what extent some of these increases will persist or to what extent they represent transitory responses to temporarily heightened uncertainty."

That fits with the comments I made earlier: If borrowers are forced to use conventional financing at current interest rates ... put 5%, 10% or 20% down ... and be qualified on the basis of reasonable debt-to-income ratios ... then home prices will have to come down to reflect the reduced buying buying in the marketplace.

That's not a bad thing, by the way, as far as I'm concerned. We shouldn't be trying to support inflated home prices that are way out of whack with borrower incomes. We should all hope instead that prices fall to a level that allows prudent borrowers to buy homes without resorting to suicide financing schemes.

July foreclosures hit a new high

There was no relief on the foreclosure front in July, according to RealtyTrac. The California firm said total foreclosures jumped 93% to 179,599 in July from 92,845 in July 2006. That leaves foreclosures at a fresh cycle high, as illustrated in this chart (the data goes back to the beginning of 2005).

California led the nation in raw foreclosure figures -- 39,013. Florida came next at 19,179, followed by Michigan at 13,979, Ohio at 13,316 and Texas at 12,441. Measured as a ratio of foreclosures to households, Nevada was the worst -- 1 foreclosure for every 199 households. Georgia was next at 1-per-299 households, followed by Michigan at 320 and California at 1-per-333.

With home sales weakening, home prices slumping, and mortgage lending standards tightening up, these foreclosure figures shouldn't come as a surprise. But they're disturbing nonetheless. Put simply, we're facing a foreclosure tsunami and there's no way to know when it will wash out.

GreenPoint goes under

Late-breaking news: Capital One Financial is shutting down its GreenPoint Mortgage unit. Around 1,900 workers will be let go and the diversified lender will take a charge of about $860 million related to the move. Capital One scooped up GreenPoint when it acquired north Fork Bancorporation at the end of 2006. GreenPoint originated about $36 billion in mortgages last year, according to the National Mortgage News stats I have -- making it the 20th largest such lender in the country.

T-bill yields plunging again

Have things stabilized? If so, someone better tell the short-term Treasury bill market. Once again, T-bill yields are tanking -- a sign of risk aversion. Three-month T-bill yields are plunging, for instance, by 112 basis points to 2.55% recently from 3.665% on Friday and 3.765% on Thursday. Bloomberg just ran a headline saying this is the biggest one-day plunge since the stock market crashed in October 1987.

Some things to ponder this Monday morning

So the post-Fed rate cut euphoria has settled down, and now we're left to ponder whether things have fundamentally changed. Well, let's look at a few indications this Monday morning ...

* Credit default swap indices (which measure corporate bond default fears) have eased a couple of basis points this morning. The Japanese yen (a measure of risk appetite) has shed about 40 ticks against the dollar. And stock averages tacked on a few points this morning, before settling back down to roughly unchanged.

* At the same time, we're still getting plenty of bad headlines out of the mortgage sector. Thornburg Mortgage said it has dumped more than 35% of its assets, cut back on borrowings, and written down the value of its loan holdings. The Wall Street Journal is also reporting that industry leader Countrywide Financial is laying off workers.

* In the bigger picture, there's one common theme worth noting: Mortgage lenders are cutting back on origination activity in the non-conventional markets -- Subprime, Alt-A, jumbo, etc. They're trying to focus much more on conventional (Fannie Mae/Freddie Mac eligible) lending funded through regulated bank/thrift channels.

The problem is that homes in many markets are unaffordable under traditional, conventional lending guidelines. That didn't matter when you could lie about your income ... find a lender willing to fund 100% of your purchase price even if you were a first-time buyer ... or dedicate 50% or more of your monthly income to your home loan payment, etc. But if that kind of lending goes away, and we truly go back to a conventional-driven market, home prices will have to fall to reflect the reduced amount of "buying power" out there.

This month's early home sales heads up for South FL

We're still waiting for the "official" Florida Association of Realtors' figures on July existing home sales. But as I've pointed out in previous months, a local real estate brokerage here in South Florida, Illustrated Properties, posts local data on for-sale inventory, sales, and prices a few days before the official figures come out. The data never lines up precisely, but the general trends are pretty similar.

Anyway, the July figures (available here) show:

* Sales dropped 31.8% from a year earlier -- to 593 units in July from 869 in July 2006.

* For-sale inventory rose 7.8% YOY to 24,024 units from 22,295. At the current sales pace, that's good for about 38 months worth of inventory.

* The median home price dropped 5.8% YOY to $292,000 from $310,000.

We're now exiting the peak spring home selling season, and things still look weak. If you're trying to sell in this market, you have to be realistic and price your property right.

More thoughts on the Fed move...

Boy, can things change quickly in this market. Yesterday at midday, it looked like financial Armageddon. Then the stock market reversed and almost closed in the green. And then this morning, as I mentioned earlier, the Federal Reserve swooped in and agreed to cut the so-called “discount rate” by half a percentage point, or 50 basis points, to 5.75%.

What’s the discount rate? It’s a rate charged on short-term loans that banks can take out directly from the Fed. The discount window is perceived as essentially a “last ditch” place for regulated institutions to borrow in times of crisis. The move is an attempt to calm the recent panic in the financial markets. The Fed did NOT cut the more widely followed federal funds target rate. It remains at 5.25%.

So what does it all "mean?" Well, we are still in the midst of a financial crisis brought about by the housing and mortgage market meltdown. This Fed move will clearly drive the price of financial shares higher in the short-term. The question is: What happens when the short-term, violent market moves settle down?

Here's my thinking on the matter: This discount rate move is a stop-gap measure that won’t suddenly make mortgages perform better. It won’t eliminate the gigantic overhang of homes for sale. And it won’t prevent banks and lenders from taking big losses on delinquent home loans. It could restore some confidence in the banking system ... or it could make people ask whether it's a sign of "panic" (i.e. is the Fed cutting rates because it knows something we don't?)

Longer-term, if the Fed move is followed by further mortgage bailout-type programs, perhaps from Fannie Mae and Freddie Mac, and/or followed up by actual funds rate cuts, then it might have a bigger impact on the housing and mortgage markets. For now, though, conditions remain very weak.

To whit: Existing home sales have dropped about 20% from their peak, while new home sales have declined 40%. The inventory of homes for sale is sky-high. A home builder optimism index has fallen to its lowest level since 1991. And a measure of home construction activity has fallen to a 10-year low.

Fed cuts discount rate ...

Breaking news: The Federal Reserve just cut the discount rate to 5.75% from 6.25%. It also left the federal funds rate unchanged, but released a statement about how downside risks to the economy have increased and how the Fed may act to support growth if necessary. Full text of Fed announcements below ...

ON THE ECONOMY:
Financial market conditions have deteriorated, and tighter credit conditions and increased uncertainty have the potential to restrain economic growth going forward. In these circumstances, although recent data suggest that the economy has continued to expand at a moderate pace, the Federal Open Market Committee judges that the downside risks to growth have increased appreciably. The Committee is monitoring the situation and is prepared to act as needed to mitigate the adverse effects on the economy arising from the disruptions in financial markets.

Voting in favor of the policy announcement were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Richard W. Fisher; Thomas M. Hoenig; Donald L. Kohn; Randall S. Kroszner; Frederic S. Mishkin; Michael H. Moskow; Eric Rosengren; and Kevin M. Warsh

ON THE DISCOUNT RATE:
To promote the restoration of orderly conditions in financial markets, the Federal Reserve Board approved temporary changes to its primary credit discount window facility. The Board approved a 50 basis point reduction in the primary credit rate to 5-3/4 percent, to narrow the spread between the primary credit rate and the Federal Open Market Committee's target federal funds rate to 50 basis points. The Board is also announcing a change to the Reserve Banks' usual practices to allow the provision of term financing for as long as 30 days, renewable by the borrower. These changes will remain in place until the Federal Reserve determines that market liquidity has improved materially. These changes are designed to provide depositories with greater assurance about the cost and availability of funding. The Federal Reserve will continue to accept a broad range of collateral for discount window loans, including home mortgages and related assets. Existing collateral margins will be maintained. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of New York and San Francisco.

EARLY MARKET REACTION:
Dollar Index: down 51 ticks to 81.22
Long Bonds: down 27/32
10-year yields: Up 2.5 basis points
S&P futures: Up about 28 points

Crazy busy ... thoughts on housing starts ... and more

I am busy ... crazy busy ... this week, with everything that's going on in the markets. That's why I haven't been able to post as much as I might like. A couple quick thoughts:

* First, the mortgage credit problems felled the small lenders. Now, those problems are spreading up the food chain. Here are a couple of stories (Reuters, AP) on what's happening at Countrywide Financial, the biggest mortgage lender in the U.S.

* The latest batch of housing data -- on July starts and building permits -- was ugly. Starts dropped 6.1% to a seasonally adjusted annual rate of 1.381 million from 1.47 million in June. Building permit issuance fell 2.8% to a 1.373 million SAAR from 1.413 million. Economists polled by Bloomberg expected starts and permits to both come in at 1.4 million.

Starts haven't been this low since January 1997, while permits haven't been this low since October 1996. The chart above shows just how severe this decline is when compared to what we saw in the early 1980s and early 1990s.

* The Japanese yen, a key measure of greed and fear, is soaring. That's a sign of wholesale panic ... and the unwinding of the so-called "yen carry trade." This Bloomberg story has more on the topic.

* I said that I'd be closely watching volatility gauges like the VXO to determine when the worst of the selling squall was over. Needless to say, these gauges continue to rise -- implying the worst of the turmoil could still be ahead of us.

NAHB index drops to new cycle lows

The National Association of Home Builders just released its latest monthly survey of builder sentiment. Here's what the numbers show ...

* The overall index sank to 22 in August from 24 in July. That was below the 23 expected by analysts and the worst reading in any month since January 1991 (when it touched an all-time low of 20).

* All three subindices declined. The index measuring present single-family home sales dropped to 23 from 24. The index measuring expectations for future sales fell to 32 from 34. And the index measuring prospective buyer traffic dropped to 16 from 19.

* Buyer traffic dropped in three out of four regions (the Northeast, Midwest and West). It was unchanged in the South.

The crisis in the housing and mortgage markets is clearly getting worse. More than 110 mortgage lenders have exited parts of the lending business -- or have gone under entirely. Notable recent bankruptcy filings have come from HomeBanc of Atlanta (a company that originated $5.1 billion in mortgages in 2006), Aegis Mortgage of Houston ($17 billion in 2006 volume), and American Home Mortgage of Melville, New York ($58.9 billion in 2006 loan volume).

At the same time, lending standards are tightening in the subprime, Alt-A, and now, jumbo mortgage markets. A just-released Federal Reserve survey showed that a net 56.3% of lenders have tightened standards on subprime mortgages. More than 40% have tightened standards on “nontraditional” loans. The category includes payment-option ARMs, loans to buy investment property, and loans for which the lender doesn’t verify the borrower’s income.

The result? Fewer home buyers will qualify to buy homes. That's clearly impacting home builder sentiment. Unless and until the mortgage markets calm down and the supply of homes for sale falls substantially, the housing market will remain weak.

Money market mayhem

In the past couple of days, the money markets have been roiled. For starters, a Canadian firm called Conventree Inc. said it hasn't been able to sell commercial paper. The company administers about $15 billion in commercial paper funds. Its lenders are now balking at providing emergency funding for $661 million in maturing debt, per Bloomberg.

For some perspective, Bloomberg notes that asset-backed commercial paper (of the type Coventree is involved in) accounts for about 53% of the $2.16 trillion in outstanding CP. ABCP is CP backed by things like car loans, credit card receivables, mortgages, and other similar loans.

Meanwhile, CNBC earlier reported that a firm called Sentinel Management Group is halting client redemptions from certain cash management accounts. I don't have any more details at this time, but if true, it's a sign that problems in the short-term money markets are getting worse.

UPDATE2: Here's a story from the FT.com giving more details on what exactly Sentinel is doing and here's another from AP pegging the amount under management by the firm at $1.5 billion. Reports are now that Sentinel did not halt redemptions from a money market fund like one retial investors would invest in. Rathert, it halted redemptions in a cash management fund used by institutional investors and higher net-worth individual investors. Marketwatch has some more details here.

Back in the office

My family's nice, relaxing vacation is over and now it's time to get back to business. I won't rehash everything that's happened the past few days, but I would like to comment on a few things ...

First, the outlook for retail spending looks a little bleak, judging by a pair of earnings reports today.

Wal-Mart Stores lowered its profit forecast, saying "Our underlying operating performance this quarter is not what we expect of ourselves, and not what our shareholders expect of us ... For the remainder of this year, our management team is focused on inventory improvements, delivering quality products at low prices, and store execution at the highest standards."

Home Depot, for its part, said second-quarter earnings fell 15%. Earnings per share may fall up to 18% this year, with the company continuing to cite a "challenging housing market" and a "tough selling environment."

Second, is it just me or does this market continue to play out like 1998? Back then, it was the rocket scientists at Long-Term Capital Management that blew the markets up. This time, it's a bunch of hedge funds that are getting blown up by computer models that refuse to play nice. Goldman Sachs (along with a couple of investors) has decided to throw $3 billion at one of its failing funds, which pulled off the amazing feat of losing 30% of its value in a week, according to the New York Times.

Third, we're seeing another mortgage firm in the line of fire this morning. Five brokerage firms have cut their ratings on Thornburg Mortgage over liquidity concerns. The company is a prime credit quality, jumbo mortgage originator and loan investor, not one that plays in the subprime arena. In other words, we are getting even more evidence of just how un-contained the supposedly "well-contained" mortgage problem really is.

What a week to take a vacation!

You try to schedule a long weekend vacation in August, figuring it'll be a pretty tame time in the markets, and this is what you get: The biggest Fed intervention in the markets in years ... more mortgage meltdowns ... and the most volatile markets in recent history. Crazy! Anyway, I'm up here in Raleigh, N.C. enjoying some time with the family, so I probably won't be posting much until I'm back at my desk Tuesday. But I'll definitely be keeping an eye on things Monday. The big question now is whether central bankers have thrown enough money at the mortgage problem to "solve" it -- and/or whether this will just lead to another bout of moral hazard.

In the meantime, you can check out some of my thoughts on the mortgage market this weekend on CNN's Open House show with Gerri Willis. It airs at 3:30 p.m. (EST) today and tomorrow on Headline News. Have a good weekend.

Ohio's foreclosure bailout experiment failing

Here's a very important story to look at if you're following the housing and mortgage markets. Ohio is one of the states getting slammed the hardest by the foreclosure wave. Some 1.07% of Ohio mortgages entered foreclosure in the first quarter, the highest share of any state in the country, according to the Mortgage Bankers Association. The national average was 0.58%.

The state tried to combat the problem by designing a foreclosure prevention/bailout program. The plan: Sell $100 million in bonds to finance mortgages that would refinance borrowers out of higher-risk, troubled loans. But now that plan is failing. The state's Ohio Housing Finance Agency is now planning to sell just $25 million in municipal bonds.

The problem, according to Robert Connell, the agency's debt director: "We got a flood of early interest ... However, we found that an overwhelming number of those were beyond the point at which this program could be of any help." In other words, they were already at the point where foreclosure was inevitable or they had past credit problems that disqualified them.

What does Ohio's program failure say about the nation's problem with bad loans? It's an unmitigated mess, that's what. The fact is, many borrowers are in homes they can't afford no matter what happens. They lied about their incomes and/or borrowed at very high debt-to-income ratios. That has left them with little financial breathing room.

Others paid too much for homes that are now worth less thousands of dollars less ... and that will likely stagnate or decline in value for some time. They have every economic incentive to walk away, take the credit hit, and try to get back into the market down the road. Sad. Very sad.

French bank gets fried by mortgage meltdown

More evidence the mortgage meltdown is anything but contained is coming from overseas this morning. BNP Paribas, the largest bank in France, has frozen three funds that invest in asset-backed securities, or ABS. BNP will not allow investors to pull money out. It will not allow investors to put new money in. In fact, it won't even provide a value for the funds -- Parvest Dynamic ABS, BNP Paribas ABS Euribor and BNP Paribas ABS Eonia. These aren't tiny funds. They're funds with $2.76 billion in assets.

BNP's reason for the freeze: "The complete evaporation of liquidity in certain market segments of the U.S. securitization market has made it impossible to value certain assets fairly regardless of their quality or credit rating." In other words, the subprime mortgage meltdown is causing pricing for all kinds of structured bonds to go haywire.

Here's the big-picture problem: We've been led to believe that the explosion of investment in all these newfangled investments (CDOs, CDO squared, CLOs) ... that the explosion in the securitization of every type of loan under the sun ... that the ballooning exposure to complex, hard-to-value, over-the-counter derivatives ($415 trillion in notional value outstanding as of Dec. 31 2006, more than quadruple the level of six years ago, according to the Bank for International Settlements) ... and that the origination of all kinds of new "creative financing" mortgages in the home loan industry ... was a good thing.

But now the rubber is meeting the road. It turns out that all these stupid mortgages are blowing up in borrowers' and lenders' faces. It turns out that these complex instruments just can't be valued accurately, if at all. It turns out that Wall Street just got too "smart" for its own good. Now, we're trying to sort the mess all out. And unfortunately, the risk of a 1998-style meltdown is very real as a result.

Heck, look at what's going on in the European money market this morning -- the overnight London Interbank Offered Rate, or LIBOR, is surging. It just soared to 5.86% from 5.35, according to the British Bankers Association, putting it at the highest level since the start of 2001. 3-month LIBOR rose to 5.5% from 5.38%. 6-month LIBOR climbed to 5.39% from 5.34%. The European Central Bank has responded by lending the market the euro equivalent of $130 billion.

This is serious stuff. It's a sign that liquidity is seizing up amid fears of subprime mortgage contagion. LIBOR hardly ever moves on credit concerns, only in response to increases in the federal funds rate. And guess what's tied to LIBOR? All kinds of short-term loans, including some Adjustable Rate Mortgages.

Bottom line: Fasten your seat belts.

Is that it?

That's the question they're asking in the bond and stock markets today. Several bond deals went through today ... the Dow soared as much as 190 points at one point ... the Japanese yen sold off ... and the credit default swaps market calmed down. It's like the "Armageddon" scenario has been dead and buried -- in just three trading days!! Talk about a bipolar market.

My guidepost to the state of the markets is going to be the CBOE OEX Volatility Index, or VXO. This chart shows the big volatility spike of a few days ago, followed by the relaxation this week. That reflects the ebbing of market fear. But I want you to notice something in the chart -- we "gapped" higher on 7/26 and as of today, have come down to fill that gap.

If ... IF ... the worst is NOT over, the VXO will hold here and turn back up. That's what happened after the February sell-off. If there's another severe leg down in the credit markets, then the VXO will likely surpass its high (around the 27 level). We'll see what happens. But you can put me in the "worst is not over" camp.

Looks like another sales forecast cut from NAR

Another month, another reduction in the National Association of Realtors' home sales forecast. NAR is now projecting existing home sales of 6.04 million units in 2007. The group's 2007 forecast peaked at 6.44 million units in February. It then dropped to 6.42 million in March, 6.34 million in April, 6.29 million in May, 6.18 million in June, and 6.11 million in July. The 2008 sales forecast was roughly unchanged -- 6.38 million in 2008 vs. a previous forecast of 6.37 million.

The bond market's China Syndrome

Bonds are having a rough go of it this morning, with long bond futures recently off 21/32 in price (and 10-year yields up about 6 basis points). What's up? For one thing, the stock market's post-Fed bounce from yesterday has carried over into pre-market trading today. More importantly, bonds are suffering due to some fear about the possibility of a financial "China Syndrome." The term refers to the actual meltdown of a nuclear reactor. The financial equivalent could be set off by China dumping its vast holdings of U.S. Treasury securities.

Why is this an issue today? In an overnight story in the Telegraph newspaper out of London, it was reported that the Chinese are making noises about dumping dollars and/or Treasuries in retaliation for U.S. pressure on China (over trade, the value of China's currency, the yuan, etc.). According to these U.S. government stats, China owned about $407 billion in U.S. Treasury debt as of May. That makes it the second-largest holder behind Japan (at $615 billion).

None of us should be as naïve as to expect China to dump a couple hundred billion dollars worth of U.S. bonds tomorrow. That would cause the value of its remaining bond reserves to plunge and U.S. interest rates to surge. That, in turn, would help drive a huge customer for Chinese goods – the U.S. – into recession. Instead, this is likely a case of China trying to put the U.S. on notice that strong anti-China trade legislation could be counterproductive.

That said, this news does appear to be hitting the dollar and Treasuries overnight. And it's likely that over the longer-term, less foreign buying of our bonds and other dollar-denominated assets will drive interest rates higher and the dollar lower.

Fed to nervous traders: "You're on your own"

I guess I could have written "Drop Dead" instead of "You're on your own" (a la that famous New York Daily News headline "Ford to City: Drop Dead") But that's a bit dramatic. The Fed didn't tell the markets to drop dead. But it's clear that Fed Chairman Ben Bernanke did NOT invoke the Greenspan put at today's FOMC meeting. Instead, he acknowledged the credit problems in the market without implying any imminent emergency rate cut. Policymakers also held onto their implicit anti-inflation bias. The full statement (with the important parts in bold) is below:

"The Federal Open Market Committee decided today to keep its target for the federal funds rate at 5-1/4 percent.

Economic growth was moderate during the first half of the year. Financial markets have been volatile in recent weeks, credit conditions have become tighter for some households and businesses, and the housing correction is ongoing. Nevertheless, the economy seems likely to continue to expand at a moderate pace over coming quarters, supported by solid growth in employment and incomes and a robust global economy.

Readings on core inflation have improved modestly in recent months. However, a sustained moderation in inflation pressures has yet to be convincingly demonstrated. Moreover, the high level of resource utilization has the potential to sustain those pressures.

Although the downside risks to growth have increased somewhat, the Committee's predominant policy concern remains the risk that inflation will fail to moderate as expected. Future policy adjustments will depend on the outlook for both inflation and economic growth, as implied by incoming information.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Thomas M. Hoenig; Donald L. Kohn; Randall S. Kroszner; Frederic S. Mishkin; Michael H. Moskow; William Poole; Eric Rosengren; and Kevin M. Warsh."

More mortgage firms melting down ...

Add some more mortgage firms to the casualty list ...

* HomeBanc Corp., a lender with operations around the Southeast U.S., just announced it will stop originating mortgages. The company said it can't borrow on its credit facilities and that it could no longer fund loans as of August 6. It said Countrywide will buy up certain retail loan origination assets.

* Late yesterday, mortgage REIT Luminent Mortgage Capital said it would suspend its dividend payments and push back an earnings conference call it had previously scheduled. Lenders are increasing margin calls and/or pulling back on funding the company's operations. The stock had been halted for most of the day yesterday.

I highlighted some comments from the company's CEO several days ago in this post. At the time, he said: "In my almost 30 years in the U.S. mortgage-backed securities market, I have never before seen the intensity of confusion, uncertainty and outright fear as right now."

* Another lender, Aegis Mortgage out of Houston, yesterday suspended all mortgage originations as well. The quote from a spokeswoman shows how chaotic the current market environment is: "We've just announced that we're going to have to suspend lending until we get this figured out."

WWBD?

You've probably heard the slogan "What Would Jesus Do?" -- abbreviated as WWJD. Well, the question on Wall Street this week is "What Will Bernanke Do?" -- WWBD, for short. (No I'm not equating policy makers with religious figures ... just trying to have a little fun with abbreviations!)

Faced with a full-scale housing and mortgage market meltdown, does Fed Chairman Ben Bernanke signal an imminent rate cut to soothe traders and investors, and give the Greenspan put a new lease on life? Or does he take the tough love path, essentially giving credence to the viewpoint that traders and investors are getting their just desserts for taking on too much risk?

Some thoughts from various media outlets ...

The New York Times, 8/5:

The Wall Street Journal, 8/5:

Reuters, 8/5:

MarketWatch, 8/6:

If you want to know my view, it's that the Fed will acknowledge the possibility that tighter credit conditions could slow the economy, but that it's far too early to panic about it. In other words, we won't get a rate cut and we probably won't get any hint of a cut. I wouldn't be surprised to see the Fed shift to a "neutral" rate bias, however.

Dollar getting crushed; More lenders pulling back

Things are really starting to get hairy now ...

* The Dollar Index, a measure of the greenback's value against six major currencies (euro, Japanese yen, British pound, Canadian dollar, Swedish Krona, Swiss Franc), is rolling over sharply amid U.S. credit quality fears. It was recently down 0.66% to 80.125, putting an end to the short-term bounce we had seen. The low to focus on is 80.016, set on 7/24.

* The most important currency to focus on, though, remains the yen. If it takes out the intraday low from a few days ago (117.61), we could be in real trouble. That's because the yen is a good barometer of overall market risk appetite. If that level gives way, you could see this selling squall turn into a hurricane.

* More lenders are weighing in with tightened guidelines. Per this Bloomberg story, Wells Fargo has stopped making Alt-A loans through brokers ... Wachovia has stopped making Alta-A loans through brokers ... AmTrust Financial has stopped making jumbo loans at LTVs above 95% ... and National City has cut back on second mortgages and stated income loans.

More mortgage market turmoil ...

I can't even keep up with all the stories flying around about problems in the mortgage market. Suffice it to say that the turmoil we've been dealing with recently has not gone away. In fact, Bloomberg reports that Bear Stearns shares are having their worst day since the day the markets reopened after the 9/11 terrorist attacks. The catalyst was a decision by Standard & Poor's to lower the firm's credit rating outlook to negative.

I've been saying on this blog that market conditions (unfortunately) look a lot like they did in 1998. We may not see as large a decline in the market as we did then. But the possibility is there. For more thoughts on that matter, click here.

UPDATE: Bear Stearns just responded as follows ...

"The Bear Stearns Companies Inc. said today that it is disappointed with S&P's decision to change its outlook on Bear Stearns. Most of the themes highlighted in its report are common to the industry and are not likely to have a disproportional impact on Bear Sterns. S&P's specific concerns over issues relating to certain hedge funds managed by BSAM are unwarranted as these were isolated incidences and are by no means an indication of broader issues at Bear Stearns.

'S&P's action highlights the concerns in the marketplace over the recent instability in the fixed income environment,' said James E. Cayne, chairman and chief executive officer of The Bear Stearns Companies Inc. 'Contrary to rumors in the marketplace, our franchise is profitable and healthy and our balance sheet is strong and liquid. Bear Stearns has thrived throughout both tumultuous and fortuitous markets for the past 84 years. We are experiencing another market cycle and we are confident in Bear Stearns' ability to succeed in this environment as it has in so many others.'

With respect to operating performance and financial condition, the company has been solidly profitable in the first two months of the quarter, while the balance sheet, capital base and liquidity profile have never been stronger. Bear Stearns' risk exposures to high profile sectors are moderate and well-controlled. The risk management infrastructure and processes remain conservative and consistent with past practices. This structure and strong risk management culture has allowed the firm to operate for all of its history as a public company without ever having an unprofitable quarter.

All other major rating agencies have affirmed their stable or positive outlook on Bear Stearns within the last six weeks."

IndyMac on mortgage standards

Interesting headline from Bloomberg a few minutes ago: "IndyMac to Make 'Major changes' to Mortgage Lending After Slump" The story says the company's CEO sent an email to employees describing the mortgage bond market as "very panicked and illiquid" and added that "Unlike past private secondary market disruptions, which have lasted a few weeks or so, our industry and IndyMac have to be prudent and assume that this present disruption, which appears broader and more serious, might take longer to correct itself."

This is just the latest in a series of steps by mortgage lenders to tighten lending standards. I discussed a couple other moves in this recent post.

... Vs. Dow 2007

Now here's a chart showing the Dow this year. You can see that we had a nice early-year rally, followed by some consolidation, and an apparent breakout to new highs. But that breakout failed, and we dropped back into our old range. Is a second consolidation period, followed by a secondary mini-meltdown, coming? Mark Twain reportedly said: "History doesn't repeat itself, but it does rhyme." And the charts, in this case, look darn familiar.

Fundamentally, the spreading credit worries, which began in subprime mortgages but have since expanded into the commercial real estate finance arena, the leveraged buyout arena, and other parts of the credit market, don't appear to be contained. That's very similar to what happened in 1998, where concerns over high-risk emerging market debt eventually infected the broader credit markets.

I found an interesting quote from former Fed Chairman Alan Greenspan, by the way, in a Bloomberg story at the time. He said, per the October 7, 1998, piece: "What we're looking at is a fundamental shift" in risk appetites. He added that he has "never seen anything like this before." Maybe nine years later, history will rhyme.

Dow 1998 ...

Here's a chart of the Dow Jones Industrial Average, circa mid-1998. You can see that we had an early-year rally, a period of consolidation, then what appeared to be a breakout to a new high in July. But it couldn't hold. The Dow dropped back down into its old range, then below it. After a period of consolidation that lasted several days, it gave up the ghost into the fall as Long-Term Capital Management blew up ...

BOE, ECB take a pass ... plus some market thoughts

It's not a surprise, but both the Bank of England and European Central Bank took a pass on the interest rate front today. The BOE left its benchmark rate at 5.75%, while the ECB kept its key short-term rate at 4%. Both of those rates are six-year highs. Economists generally expect the BOE to keep rates at these levels for now, though they're expecting at least one more ECB hike in September.

Meanwhile, capital markets are trying to find some stability after the wild swings of the past few days. We've seen gigantic moves up and down in everything from stock prices to bond prices to credit default swaps and more. Those betting the worst is over are dueling with those betting there's more chaos to come. I'm in the second camp -- in fact, today's market environment looks a lot like 1998 to me both technically and fundamentally. I wouldn't be surprised to see some sizable earnings hits and lending problems, just like we did back then when Long-Term Capital Management blew up. We'll see...