Interest Rate Roundup

Thursday, December 28, 2006

What inventories look like on a chart ...

To follow up on my last post, here is a chart showing total existing home inventory levels over the past six years. You can see that supply climbed steadily during the lion's share of the boom, then skyrocketed in 2005 and early 2006. That little, itty-bitty sideways pattern of the past few months? That's what is responsible for all the happy talk about how we're "solving" the inventory problem.

Look, the bottom line is we have an Everest-sized mountain of homes on the market. And it's likely to increase in early 2007 as well, once all those "re-listers" put their homes back on the market. I doubt we'll see a supply surge as severe as we saw in 2006. But my bet is that it'll definitely show up on this chart come February, March, and April. And I'm guessing a lot of economists will talk about how they're shocked ... SHOCKED ... to see supply climbing again.

A bounce? Yes. A new boom? Er ... no.

Existing home sales for November just hit the tape. Here’s the scoop on the numbers …

* Sales rose 0.6% on the month vs. forecasts for a 0.8% decline. The sales rate came in at 6.28 million units vs. 6.24 million a month earlier. But it’s down 10.7% from a year earlier (7.03 million units in 11/05).

* Inventory dropped a bit – 1% to 3.82 million units from 3.86 million units in October. That’s a 7.3 month supply at the current sales rate, just off the cycle peak of 7.4 months in October.

* Prices dropped again. The median price of all existing homes (condos + single family + co-ops) slipped to $218,000 in November from $219,000 in October and $225,000 a year ago. On a percentage basis, single-family only home prices dropped at a rate of about 3.6%. That’s the second-biggest decline ever, behind last month’s 4.2% drop.

My thoughts on these numbers ...

Like new home sales yesterday, existing home sales bounced in November. I expected this given the dip in mortgage rates we’ve seen lately. But are these numbers really all that good? I’d argue no, when you look at the big picture. Consider ...

- The sales rate is basically going nowhere, up a miniscule 1.1% from the September low and well off the high (-13.6%) of 7.27 million units in June 2005. That’s not exactly a rip-roaring rally.

- Inventories? Yes, they’re down 1.1% from the July cycle peak of 3.86 million units. But when you consider the supply of homes for sale skyrocketed 117% from the January 2001 low of 1.77 million units through the July peak, that 1%-ish decline doesn’t look so impressive. I chose January of '01 because that's when the Fed started cutting rates to "save" the economy from the after-effects of the stock market bust. It's when I believe the great bull market/bubble market for real estate got underway.

- That’s not all, either. It is absolutely normal and customary for for-sale inventory to stabilize or decline late in the year. People who don’t sell their homes during the peak spring and summer selling season often pull those homes from the market for the holidays. Then they re-list early in the following year.

You see that seasonal pattern time and time again. It happened in the boom years of 2001 ... 2002 ... 2003 ... and 2004. Even in 2005, when the market had already started topping out, inventory levels stabilized late in the year, before surging again in early 2006. I expect supply to start rising again after the first of the year, and set a new cycle high by spring 2007.

There is simply no getting around a few basic facts:

1) While sales aren’t falling sharply anymore, they’re not improving much, either.

2) Supply is still at astronomically high levels and ...

3) Homes remain relatively unaffordable, despite the recent decline we’ve seen in mortgage rates and home prices. It’s going to take bigger price concessions ... more incentives ... and most importantly, lots of TIME to work off these conditions. In other words, 2007 should be another weak year for the housing market.

Wednesday, December 27, 2006

Long bond break ...

Here's a chart of the continuous U.S. Long Bond future. You can see that we broke below an uptrend line that dates back to the late June low. Ten-year Treasury note yields also broke above a downtrend line that came into play just over 4.6%. Here's a story with my comments on the action.

Worth noting: The recent rise in rates appears to be cutting the legs out from under the Mortgage Bankers Association's purchase application index. That index had been climbing until the past two weeks. It then dropped 5.9% in the week ended 12/15 and 10.6% in the week ended 12/22. These numbers are notoriously volatile this time of the year, so the size of the declines is likely exaggerated a bit. But if we continue to head lower in January, we'll know it's more than that.

A new post on new homes ...

Welcome back everyone. I hope your holiday was as enjoyable as mine. Now let's get down to business. We just got the latest read on the new home market. Here's my take on the November numbers and what they mean. Enjoy ...

* New home sales rose 3.4% between October and November, vs. forecasts for a 1.6% gain. The seasonally adjusted annual rate of sales hit 1.047 million units, up from 1.013 million units in October. However, that’s still down 15.3% from a year earlier (1.236 million in 11/05)

* The supply of homes for sale slipped to 545,000, or 6.3 months at the current sales rate. That’s down from 558,000 and 6.7 in October. However, we are only down 28,000 units, or 4.9%, from the all-time U.S. inventory record of 573,000 units for sale in July. That 573,000 reading, by the way, was a 96% rise from the 2001, pre-boom low.

* Median prices even rebounded up 5.8% year-over-year from last November to $251,700. That’s the biggest YOY gain since June. In fact, prices aren’t far off their high to date of $257,000 in April, if you believe these stats. I personally don’t think they’re capturing the huge amount of incentives being thrown at buyers. Many builders are also slashing list prices – by as much as 20%, 30% or more in my market down here.

My analysis:

Interest rates started falling in the summer. But home sales didn’t react at first – they remained weak. That changed last month. Mortgage rates finally came down enough to spark buyer interest, causing sales and home prices to bounce off their lows.

But I wouldn’t break out the New Year’s bubbly just yet.

For one thing, interest rates have leveled off again. You can see the impact that’s having in the Mortgage Bankers Association’s weekly purchase application index. It dropped almost 6% two weeks ago and another 11% in the most recent week. Some of this could be holiday-related "noise." More likely, it’s that this rate-fueled bounce is running out of gas.

For another thing, there’s the massive inventory overhang we’re dealing with. A 5%, four-month decline isn’t much when you consider the five-year, 96% run up that preceded it. And that’s just the new home market. The market is flooded with existing homes, too.

Longer term, the approaching spring selling season is for all the marbles. I expect many of the homes that didn’t sell last year – and that were pulled off the market for the holidays – to hit the MLS in the spring. Throw in the tepid economy and a likely tightening in mortgage standards, and I think you have a recipe for disappointment. In other words, look for the housing market to remain weak in 2007.

Friday, December 22, 2006

packing it in soon - best holiday wishes!

I'll be packing it in soon for the long holiday weekend, so I may not post for a while. But please allow me to wish you a happy and healthy holiday season. Also, thanks for reading. Interest rates may not be the most exciting topic -- I certainly won't be discussing the finer points of hybrid adjustable rate mortgages at the New Year's Eve party I'm going to in a few days! But they're absolutely essential to the performance of the markets, and I think we're in for some real fireworks in 2007. So be sure to check back for all the latest. Cheers!

"Good" news, "Bad" reaction, take two

Several days ago, I mentioned that the Consumer Price Index came in tamer than expected. Bonds initially rallied on the news, but ultimately rolled over and finished the day down a bit in price, up in yield. We're getting another bout of that today. The economic data showed ...

* Durable goods orders, excluding transportation, dropped 1.1% in November vs. expectations for a gain of 1%.

* The gains in November personal income and spending were slightly below expectations, by 0.1% each, according to Bloomberg.

* The core personal consumption expenditures price index was flat on the month, vs. forecasts for a 0.1% gain. That brought the YOY PCE core inflation rate down to 2.2% from 2.3% in November.

You might expect bonds to rally on this news. But you'd be wrong. Long bond futures were recently down 22/32, in fact, a fairly large move. Ten-year note yields shot up more than 6 basis points.

I don't want to make too much of this given that the markets are thin as a reed this time of year. But it is worth noting the odd reaction to arguably bullish data.

Thursday, December 21, 2006

Mortgage interest paid vs. GDP -- Yikes!

Every once in a while, I stumble across an odd statistic -- something I haven't seen mentioned anywhere else. That's the case today. Bloomberg just published an item on the amount of mortgage interest paid in Q3 vs. Gross Domestic Product. It turns out we spent a whopping $625 billion in mortgage interest last quarter, the most ever in nominal terms and the most ever in relation to GDP (4.72%).
These figures aren't exactly a surprise, of course. I just think they speak volumes about the broader problem with the U.S. economy -- growth has been extremely dependent on a massive run up in home prices and a related surge in mortgage debt. The only question now is, "How severe will the fallout be?"

Growth V. Inflation, round 2,653

The never-ending debate between growth and inflation continues today. This time, it's the Philadelphia Fed index provoking some discussion (and by the way, I just picked that number out of the blue -- this isn't really the 2,653rd time I've blogged about this topic!). Here are the details in the Philly index ...

* The overall index sank to -4.3 in December from 5.1 in November. The "experts" were looking for a reading of 4, so this was clearly a disappointment.

* The new orders sub-index was negative for the third time in the past four months (-2.4). But the index measuring employment rose to 7.9 from 0.2.

* But those two negative readings on the GROWTH front have to be measured against problematic readings on the INFLATION front. While the prices paid index dropped (to 20.6 from 26.7), the prices received index rose (to 9.9 from 5.7).

* Moreover, survey respondents had higher expectations about future inflation. The index measuring expectations for input prices six months in the future jumped to a five-month high of 40.8. The index for future received prices also rose to 29.9, nearly twice the November reading and the highest since July.

We've got one heck of a thin market here ahead of the holidays. So we're seeing some weird trading action off the numbers. Treasuries originally went nowhere on the news. Then half an hour later, they rallied several ticks. The 10-year T-Note was recently yielding 4.55%.

It remains an open question whether we can break to new yield lows or whether we've seen about all we're going to see in that department for this rally. But the Fed clearly doesn't want to encourage any rate cut speculation. Richmond Fed President Jeffrey Lacker is out on the tape saying: "The risk that core inflation surges again, or does not subside as desired, clearly remains the predominant macroeconomic policy risk."

Wednesday, December 20, 2006

New home inventories much worse than they appear?

Here's a chart showing the supply of new homes for sale on the market from Bloomberg. Today, I want to explain why it might be "wrong" ...

When you read some of the earnings releases from major U.S. home builders, one thing jumps out at you: Cancellation rates. They're off the charts. In just the past few weeks ...

* U.K. builder George Wimpey, which builds homes in five U.S. states, says HALF its U.S. customers canceled home reservations in the second half of this year.

* U.S. builder Hovnanian said more than a third of its home buyers canceled purchase contracts in the company's fourth quarter. That's up from 25% a year earlier.

* Luxury builder Toll Brothers said 585 orders were canceled in its most recent quarter. That equated to a 37% cancellation rate, double the 18% rate in Q3 of fiscal 2006.

What's going on? Traditional buyers are increasingly unable to sell their existing homes in order to move into new homes they contracted for. So they're walking away. Ditto for speculators who snapped up new homes months ago, expecting to be able to close on them and then flip them for big profits. They'd rather lose deposits of $10,000 or $20,000 than close on a home whose value has dropped by $30,000, $50,000 or more.

Now here's where things get interesting: The supply of new homes for sale "officially" shot up 96% from its 2001 low through its July 2007 peak (292,000 in 3/01 vs. 573,000 in 7/06). Since then, supply has officially dropped a bit -- 1.7% to 563,000.

But the Census Bureau's figures don’t include the impact of order cancellations. When you sign a contract to buy a new house, it’s recorded as one sale. The official tally of homes for sale drops by one. But if you walk away from that contract, your property is not added back to the inventory count.

With cancellation rates surging to 30%+ at several major builders, you have to wonder what the TRUE supply level is in the new home market. There's no way to know for sure. But if you were to increase the official count of 563,000 by a conservative 20%, you'd boost supply by almost 113,000 homes. A 30% bump gives you an additional 169,000 homes.

Tuesday, December 19, 2006

Sorry for the lack of posting today...

Been trying to catch up on some other duties, appointments, and all that good stuff. Anyway, here are two quick hit comments:

* Housing starts bounced. But building permit issuance fell ... again ... to the lowest level since December 1997. Gotta love that "bottom" in housing.

* Producer prices jumped 2% -- the single biggest monthly gain since 1974. Bonds said: "What me, worry?" and finished the day roughly unchanged.

Seriously, though, this PPI number (and the past few ones) have been distorted by weird car and light truck price changes. So I understand why the market is taking the big increase with a grain of salt.

But the fact of the matter is, longer-term Treasury notes and bonds have virtually ignored any and all signs of inflation for the past three years. Whether it's foreign inflows into our bond market that are keeping long-term yields low, or whether the bond vigilantes are all off somewhere getting intoxicated, I don't know. But it is what it is. Funny, though, that interest-sensitive stocks took a bit of a licking today despite the strong overall stock market.

Monday, December 18, 2006

NAHB Housing Index a mixed bag

The National Association of Home Builders' monthly index measuring builder sentiment was just released. The overall index dipped to 32 in December from 33 in November. The sub index measuring present sales was flat ... the index measuring the outlook for future sales rose 3 points ... and the index measuring prospective buyer traffic dropped 3 points.

The index's cycle low to date was 30 in September. These latest figures show more of the same -- we're floundering around near very low levels, with no discernible progress lower OR higher.

Friday, December 15, 2006

bonds close DOWN

What do you know? The bonds actually finished DOWN in price by a tick and rates finished pretty much flat. I said today's close would be important, and I believe you simply cannot ignore the fact bonds FELL today given the supposedly "great" news on inflation.

Once again, I'll wonder out loud: Could the best news on inflation be behind us? I mean, am I the only one who noticed that crude oil prices appear to have bottomed and are now heading toward $65 a barrel? What about the RJ/CRB Commodity Price Index, which bottomed on 10/4/06? Or the fact global economic growth remains relatively strong? Couldn't these forces at least stem the DECLINE in inflation, if not help boost prices in the coming months.

And one last thing ... did anyone notice the Federal Reserve Bank of Cleveland's median consumer price index? It's another measure of core inflation. Not only did it rise 0.2% in November (vs. the core CPI, which was unchnaged), but it's also now rising at a 3.7% annual rate. Just something to mull over this fine Friday afternoon.

bond market u-turn?

What's more important than any economic data release? The market's reaction to that data! And boy are things getting interesting in the Treasury complex.

Bonds shot up in price right after the CPI figures came out, and yields dropped fast. Indeed, the long bond was up about a full point earlier. But as the day wears on, those price gains/yield drops are moderating quickly. Today's close could be very important -- if we can't hold these gains, maybe the market is saying the best inflation news is behind us for now.

CPI downside surprise

Well, well, well, that was certainly a surprise. The wizards in Washington that put together the Consumer Price Index say prices were flat in November vs. October. The "core" CPI, which excludes food and energy, was also unchanged. Both readings were below forecasts for 0.2% gains. Price declines were widespread in vehicles (-0.8%) gasoline (-1.6%), education and communication (-0.2%), tobacco (-0.3%) and commodities (-0.4%). The year-over-year change in core CPI is still elevated at 2.6%, but down from the September peak at 2.9%.

Now, I have a hard time believing that real world prices are declining to this extent. I don't see it in my everyday life. But hey, the gubmint says they're dropping and that's all that matters to the market. Bonds are up in price, down in yield, while the dollar index is giving up some of its recent short-term gains.

Thursday, December 14, 2006

Early peek at Nov. sales in my neck of the woods

I live and work in South Florida, which has the dubious distinction of being one of the most overvalued real estate markets in the country. Rampant speculation. Extreme levels of mortgage fraud. Rising foreclosures. Home prices that are way out of whack with local incomes. We've got it all!

So what about sales? Inventories? Prices? Where do they stand? The official figures from the Florida Association of Realtors come out around the same time each month as the national data. That's due December 28. But one local brokerage posts "unofficial" sales data ahead of time here in Palm Beach County. To summarize, in November, here's the year-over-year change for ...

Sales: -60.4%
Inventory: +95.7%
Median price: -7.9% ($25,000)
Average days on market: +51%

That's a pretty nasty batch of numbers, all things considered. We've seen a pickup in mortgage applications for purchase loans in late November and early December. So the sales figures might pick up in December (remember that existing home sales are based on closings, not contract signings. That means sales for Nov. reflect weak contract activity in Oct. IF contract signings pick up with purchase apps, Dec. sales would therefore reflect stronger apps in Nov.)

Even if that's the case however, the supply overhang we're dealing with down here is humongous. Exhibit A: Based on November's sales rate (529 units), and November's inventory count (22,171) we have roughly 42 months of supply hanging over our heads. That ... to put it mildly ... ain't so good.

speaking of inflation ...

Import prices rose 0.2% in November vs. forecasts for a 0.1% rise. Excluding petroleum, prices jumped 0.7%, more than offsetting October's 0.5% "core" decline. Strip out ALL fuels (including natural gas) and you get a 0.1% rise. Food and beverage prices jumped 0.4% and industrial supply prices rose 0.6%, while most other categories were relatively flat. Export prices climbed 0.4%

Wednesday, December 13, 2006

An inflation TIP off?

A key indicator of real-time, market-based inflation expectations is the spread between yields on Treasury Inflation Protected Securities, or TIPS, and yields on nominal Treasuries of similar maturity. The wider the spread, the more inflation fear is being priced into the market. If nominal 10-year Treasuries are yielding 4.57%, for instance, and 10-year TIPS are yielding 2.22%, the spread would be 235 basis points. That tells you the market is roughly expecting inflation to run at a 2.35% rate over the next several years.

The 10-year TIPS spread collapsed this summer and early fall, allowing Treasuries to rally. But that spread has been gradually widening out and today, it hit 235.33 bps. That's the highest since September 29. This isn't a big deal ... yet. But if this week's November Consumer Price Index report surprises to the upside, we could see TIPS spreads break to the upside as well.

More on delinquencies and foreclosures

Lots of data out today on the credit front. In addition to the monthly RealtyTrac figures earlier, the Mortgage Bankers Association just released their QUARTERLY figures for Q3. The details:

* The overall 1-4 unit delinquency rate hit 4.67%, up from 4.44% a year earlier. Outside of the 4.7% rate in Q4 2005, which was likely due to hurricane-related DQs, this is the highest reading since Q2 2003 (4.97%). DQs hit a high of 5.35% in Q3 2001, when the U.S. economy was in recession

* Subprime DQs are rising fast -- to 12.56% in Q3 from 10.76% in Q3 2005

* ARM DQs are, not surprisingly, rising faster than fixed rate DQs. More than 3% of prime credit ARMs were delinquent. Subprime ARM delinquencies are above 13%.

* The foreclosure rate popped up to 1.05%, the highest since Q1 2005.

The MBA's survey covers 42.6 million loans, so it's a comprehensive snapshot of mortgage market performance. With prices stagnant or falling in many parts of the country, and so much "Frankenstein Financing" doled out in the past couple of years, it's likely that delinquency and foreclosure rates will rise in the months and quarters ahead.

RealtyTrac: Foreclosures surging ...

Just to follow up on the posts I've had recently about credit quality, RealtyTrac reported that foreclosures climbed 4.1% month-over-month between Oct. and Nov. What's striking is the year-over-year surge -- a whopping 68.1%. The company says 120,334 homes were in some stage of foreclosure last month, or 1 in every 961 homes. This is a new data series, so we don't have a lot of history. But this chart from Bloomberg shows what it looks like graphically.

Technical Take on the 10s

Back on December 6, I said 10-year Treasury futures looked like they were at a crossroads -- testing a downtrend that goes back a few years. Prices failed roughly around that level. Now, let's zero in on the shorter-term picture. You can see in this daily chart that 10-year Notes broke out to the upside on heavy volume in late November. But now we're pounding away at the breakout level (roughly 108 20/32 - 108 22/32). Will the mega-breakout prove to be a fake out? That would likely catch a lot of market players by surprise.

Watch those bonds!

Whopper of a surprise on retail sales for November -- up 1% on the headline vs. a 0.2% forecast and up 1.1% excluding autos vs. a 0.3% forecast gain. We're seeing U.S. long bond futures get whacked (-21/32) and the 10-year Treasury yield challenging key upside resistance at 4.54%/4.55%. If we break above this yield level ... in a market where everybody and his brother is long bonds ... watch out. It could be a significant reversal. The next major catalysts for a move in bonds -- fundamentally speaking -- are November import/export prices (out tomorrow) and especially the November Consumer Price Index (out Friday)

Tuesday, December 12, 2006

Fed does nothing, take 4

Here's the text of the just-completed Federal Open Market Committee meeting. The Fed kept rates stable at 5.25% for the fourth meeting in a row ... with the last hike on June 29.

Some highlights from the post-meeting statement:

- The Fed pointed out that economic growth has slowed this year, attributing it to a "substantial cooling of the housing market." The qualifier "substantial" is new, indicating that the Fed may be more pessimistic about housing.

- The Fed said that "readings on core inflation have been elevated, and the high level of resource utilization has the potential to sustain inflation pressures" -- references to the fact the core CPI is still above the Fed's preferred range and the fact the unemployment rate remains low. But officials also argue that stabilization in energy prices and past rate hikes will work to alleviate those inflation pressures.

- Once again, Jeffrey Lacker dissented in favor of a quarter of a percentage point interest rate hike.

What I can't understand is why the Fed continues to focus purely on the REAL economy and say nothing about the FINANCIAL/ASSET economy. The European Central Bank makes a point of discussing money and credit growth. Other central bankers do, too. Yet the Fed continues to stay mum about the explosion in new credit, the worldwide surge in money supply, the spree of multi-billion dollar LBOs, the gigantic surge in commercial real estate values, and several other indicators that monetary policy is anything but tight. Sigh...

a cornucopia of mortgage credit warnings

One major housing boom enabler was ridiculously easy lending. When interest rates started to rise in 2004, and the mortgage business started cooling, lenders didn't pull back. Instead, they offered more and more exotic forms of loans in order to keep the party going. Now that housing is sinking, we're seeing defaults surge across the board.

One example: Countrywide Financial reported its November operational results this morning. The portfolio delinquency rate climbed to 4.57% from 4.43% in October. More importantly, if you exclude last fall's hurricane-influenced jump (11/05 and 12/05 DQs rose as borrowers in hurricane-affected regions fell behind on their mortgages in droves), you find that's the highest DQ rate since December 2002. The servicing portfolio's foreclosure rate is 0.60%, up from 0.43% a year earlier and the worst in any month going back to April 2002.

I warned we were staring a major loan loss problem in the face several times in the past year, including in this column from back in July. Other warnings are now popping up all over the place. Here's one from Bloomberg, quoting Fitch as saying mortgage-backed and asset-backed debt, particularly in the subprime world, will perform poorly next year. Losses on subprime mortgage bonds issued in 2000 are about 5.5% to date. Fitch says cumulative losses over the life of 2006 securitized subprime loans will top 7% -- the worst performance EVER.

The Wall Street Journal also has a couple more stories on the topic today, one titled "Double Trouble for Mortgage Shares: Dual-Loan Borrowers Pose Added Risk" and another "Debt Investors' Double Burden." And several government officials weighed in at a housing market conference put together by the Office of Thrift Supervision. AP summarizes the comments here.

Monday, December 11, 2006

Heavy week for economic data; Fed to talk tough?

Not a heck of a lot going on in the markets today ... but that will change soon. The reason? It's a heavy hitting week of economic data. We have two key November inflation reports on 12/14 (import/export prices) and 12/15 (Consumer Price Index). We also get retail sales figures on 12/13 and industrial production/capacity utilization stats on 12/15. To top it all off, the Federal Open Market Committee meets to discuss interest rate policy tomorrow.

I wouldn't be surprised to see an uptick in inflation given the rebound we saw in energy prices last month. I also wouldn't be surprised to hear hawkish comments from the Fed. In this environment of abundant liquidity (see my posts about the LBO mania) AND a weak dollar, the Fed can't afford to throw more gasoline on the fire. If officials talk about easier monetary policy or downgrade their economic outlook, we could get even more asset inflation and/or dollar depreciation -- things I doubt the Fed wants to see.

FYI, has a good free site with all the dates for upcoming economic reports (and market forecasts for them). You can find it here.

Friday, December 08, 2006

Bloomberg: Mortgage bond derivatives get whacked

If you're looking for more color on the action in subprime mortgage bonds this week, check out this Bloomberg story. It points out that subprime mortgage bond derivatives are having their worst week of 2006. Specifically, "credit default swaps based on an index of bonds rated BBB- and consisting of sub-prime mortgages made this year fell 2.3%, to 95.50 today, according to Deutsche Bank AG ... DB calculates that the annual cost to protect against default on $10 million of 2006 BBB- mortgage bonds is up to $380,000 from $310,000."

There are lots of other stats in there worth chewing over, too, if you feel so inclined to read.

More mega-deals on the new home front

I've said that in a number of previously hot markets, home prices could fall 20% to 30% ... or more ... depending on property type, location, etc. Here is just one case of a new home builder who's running a big sale in my neck of the woods this weekend. The sale is Dec. 9, so the link may not work after that. But to highlight just one offer, a 3BR unit that previously would have sold for $336,725 is being offered for $259,900 --more than $75,000 off, or 22.8%. Another previously listed for $253,790 is being promoted at $168,790. That's an $85,000 price cut, or 33.5%.

Some buyers are clearly responding at these price levels. The key question is, what happens when the mega-sales end? Will buyers continue to step up to the plate at higher prices? Or have they been conditioned, like many car buyers have, to expect even better deals the next day ... next week ... next month ... next quarter? Certainly there are some parallels between what the car makers faced a few years ago and what the builders face now:

Auto demand dropped after 9/11 when the economy slumped. But instead of drastically cutting production to match supply with reduced demand, the Big Three turned to super-aggressive incentives. That juiced sales for a time. But every time the car makers cut back on the offers, buyers cut back on their buying. Companies like GM and Ford are still struggling with this market dynamic.

This time around, housing demand started falling last year as the bubble burst. Builders didn't cut back on production quickly enough, and supply surged to the highest level in U.S. recorded history. The builders are cutting back on starts now, and slashing prices to move product. But if they can't resist the urge to bump production back up every time sales rise a bit, they'll end up in the same boat as the automakers -- consistently relying on new and more generous deals to attract customers.

It'll be extremely interesting to watch how the supply/demand picture evolves in the 2007 spring selling season. But I think both builders and home sellers will be surprised at just how many homes come to market after the holidays.

crazy market action today

What a day! The November jobs report showed the economy added 132,000 nonfarm positions. That was above the 100,000 expected by economists, according to Bloomberg. Unemployment ticked up a bit to 4.5% from 4.4%, but average hourly earnings (on a year-over-year basis) jumped 4.1%. That tied September for the biggest increase since March 2001 and seemed to indicate renewed wage pressures.

Treasuries initially sold off on the news. The dollar rallied. Then everything reversed, with Treasuries rallying and the dollar selling off. Then CNBC aired an interview with Treasury Secretary Hank Paulson, who reiterated his support for a strong dollar and said "I feel very good about the strength of our economy right now." The result? We switched directions again.

Somebody pass the Maalox!

Why Ownit is a potentially huge deal

Evan as the housing market started deteriorating late last year, an interesting thing happened -- conditions in the mortgage bond market did not. The excess "spread," or interest rate cushion that buyers of mortgage bonds demand over Treasuries stayed relatively flat ... and even declined for a time. In other words, mortgage bond investors were exhibiting little fear about defaults surging ... losses rising ... and all that.

This is changing, fast. Ownit's demise ... and other reports of a rapid deterioration in mortgage credit quality, which I've been chronicling here ... appear to be putting some fear in the heart of subprime mortgage bond buyers. This development definitely bears watching. IF lenders are forced by the secondary mortgage market to tighten loan standards, it could exacerbate the downturn by making it tougher for marginal buyers to obtain mortgages to purchase homes.

Thursday, December 07, 2006

11th largest subprime lender goes POOF!

The fallout from the housing bust continues. This week, the 11th largest subprime mortgage lender in the country, basically went POOF! Here's a MarketWatch story with the details. The culprit appears to be the forced buyback of loans from mortgage investors. In a nutshell, subprime originators make loans, then sell them off to end investors. If those loans go bad quickly, or if other conditions are met, the investor can put those loans back to the originator. The company, Ownit Mortgage Solutions of California, reportedly ran out of cash to buy those loans back. According to one employee, the company (which made more than $8 billion in loans last year) basically shut down overnight.

I'm not surprised one bit. I've been following this industry in one capacity or another since 1998 -- ironically, the last time there was a mega-implosion in the subprime lending sector. Back then, the Russian bond default that led to the Long-Term Capital Management crisis also caused ALL high-risk debt markets to seize up. Subprime lenders had been originating lots of high-LTV loans, particularly a hot product called the 125% LTV home equity loan. Just like the name suggests, you could borrow up to 125% of your home's value as a second mortgage.

Almost overnight, the demand for bonds backed by pools of high risk mortgage loans dried up. Went Poof! That caused several firms to fold or sell themselves off to better capitalized institutions. It's worth noting that the 1998 implosion happened at a time when home prices were still relatively reasonable vs. incomes, and when housing wasn't coming off the biggest bubble in U.S. history (like it is now). Will the fallout be worse in this cycle? We'll see.

Wednesday, December 06, 2006

10-year T-Note at a crossroads...

We've had a quite a run off the bottom in interest rate futures. Yields have fallen at the same time. Now, we're at a crucial technical crossroads.
I charted the benchmark 10-year Treasury Note continuous future here. You can see we're testing a downtrend connecting the peaks in June 2003 and June 2005. A break above, say, 109 18/32 would be significant. On a yield basis, the corresponding uptrend support comes into play around 4.36%-4.40%.

Rent growth poised to slow: WSJ

I've been predicting for a while that the surge we've seen in rents would subside. Consider it another side effect of the housing bust. Rents surged during the late stages of the housing boom for a few reasons (many apartments were converted to condos, taking out supply ... frustrated potential home buyers gave up and rented instead, etc.) You can read this piece I wrote a little while back for full details.

Lo and behold, the Wall Street Journal is reporting on this trend today. I can't link to the paid subscription site. But here are a couple key facts ...

* Reis Inc., a New York research firm, says the number of apartments for rent ticked up for the first time in two years in Q3

* Reis Chief Economist Sam Chandan cut his forecast for 2007 rent growth to 3.6%. That's down from 4.2% this year.

* In addition to traditional apartment "re-conversions" (apartments that were converted to condos going back to apartments), there are tons of "shadow inventory" units. Those are units that individual condo buyers snapped up during the flipper frenzy, hoping to unload at a profit. But now, they can't sell. So they're choosing to rent instead to help pay their mortgages. This inventory doesn't get captured in traditional analysis.

One anecdote: An apartment complex right outside my neighborhood was snapped up for conversion many months ago. It was flipped back to a rental complex rather quickly. Then in the past few weekends, I've seen signboard wearers promoting one month free rent.

Private equity insanity

In the "You gotta be kidding me" department, CNBC just reported on air that Deere (market cap $22.6 billion) has been rumored to be a private equity target. Same with Barnes & Noble. Only a few days ago, the New York Post suggested Home Depot could be the target of a $100 billion leveraged buyout.

Excuse me for saying so, but this is completely nuts. We have too many investment bankers with too much time on their hands, if you ask me. And yes, this is yet another indication the Fed's "tight money" campaign has utterly failed. There's still way too much "Money, Money Everywhere!"

A bounce vs. "The Bottom"

The Mortgage Bankers Association's home purchase application has spiked higher in the past couple of weeks. Mortgage rates have been falling for a while, but initially, this index did not respond. That has obviously changed. The reading of 426.60 for the most recent week is up from a low the week of 10/27 at 375.60. Luxury home builder Toll Brothers also talked yesterday about how some markets appeared to be bottoming. And I believe November was clearly a better month for sales than Sept. or Oct. (seasonally speaking).

But the key question is this: Is this just a bounce or (drum roll please) "THE BOTTOM?" I'm skeptical of the latter. The fact is, we've had a 15-year uptrend in residential real estate off the 1991 recession low. There were minor hiccups in 1994/95 and then 1999/2000, to be sure, but they weren't big. Then beginning in 2001, everything went nuts. This culminated in the biggest housing bubble in U.S. history, which topped out last summer. I find it EXTREMELY hard to accept that this can all unwind in about 12-15 months, and that it'll all be wine and roses from here.

Some other things to consider ...

- Yes, sales are rising. But many of those sales are being "bought" with extremely aggressive incentives. One builder down here is offering up to 37% off the previous list price on some homes, and allowing buyers to "move in for $1." Another trumpeted how its Oct./Nov. sales surged from the previous two months due to a "Home-A-Palooza" promotion. That’s true ... but only because the builder cut prices so much, the average value of those orders dropped 33%.

- Builders and individual home sellers will likely have to cope with the "GM problem." Home buyers are being conditioned to expect big deals, just like car buyers were taught in the post-9/11 incentive frenzy. Will they still buy if those discounts go away? My bet is that builders will try to pull back, but that will spook buyers, and they'll have to resort to discounts, freebies, and price cuts again.

- Pundits are underestimating the magnitude of the supply glut we have right now ...

The supply of new homes for sale shot up about 96% from its 2001 low through the July 2006 peak (292,000 in 3/01 vs. 573,000 in 7/06). That was the highest in U.S. history. Since then, despite all the hoopla about how inventories are coming down, we’ve dropped just 2.6% to 558,000.

The supply of existing single-family homes for sale rose 108% from its 2001 low to its July high (1.59 million in 1/01 vs. 3.31 million in 7/06), also a record high. Since then, we’ve dropped just 0.6% to 3.29 million units. And that's during a time of year (the pre-holiday/holiday season) when inventories almost always stagnate or decline. What do you think is going to happen when all those sellers who pulled their houses from the market for the holiday season re-list? Inventories will shoot higher again, most likely beginning in January or February.

- Existing single-family home prices dropped the most on record in October (3.4%). New home prices dropped more than 9% in September, though the government says they bounced back a bit in October. I believe prices will need to fall further to clear all this inventory, and that the housing market will remain weak through at least 2008.

That's my latest thinking, anyway. Feel free to accept or reject as you see fit!

Tuesday, December 05, 2006

Another reason for rising delinquencies ...

This chart (courtesy of Bloomberg) shows the Mortgage Financial Obligations Ratio, released quarterly by the Federal Reserve. The MFOR (don't you love these alphabet soup acronyms?) measures the percentage of disposable personal income going toward paying off mortgage debt, homeowners insurance and property taxes.

You can see that mortgage payments are now consuming the biggest chunk of disposable income in U.S. history -- 11.6% in Q3. And let's be honest ... many lenders have been writing mortgages at 40%, 50%, even 60% debt-to-income ratios. This is another major force behind the rising delinquency trend.

Delinquency rate visual

I mentioned earlier that residential real estate loan delinquencies are on the rise. I also mentioned that DQ rates are still low by historical standards. Here's a visual to give you a better idea of what I'm talking about. This chart shows the DQ rate going back to the early 1990s, the last time we had a fairly significant housing bust. This time around, the boom/bubble was much, much bigger -- the largest in history. Does that mean the downturn could also be worse, pushing DQ rates into the high 2% range from the 11-quarter high of 1.72% in Q3 2006? I don't see why not.

bankruptcy filings rising again ...

You may recall that last year, new rules were passed that govern bankruptcy filings. They made it tougher to get your debts wiped away, forced more potential filers to undergo credit counseling and take other steps. Bankruptcy filings skyrocketed ahead of the changes, and peaked at 667,431 in Q4 2005. But after dropping all the way to 116,771 in Q1 2006, filings are on the rise again. They climbed to 171,146 in Q3 from 155,833 in Q2. Higher interest rates ... the housing slowdown ... and record-high debt service ratios are all to blame, in my view.

Economic mixed bag

We just got another batch of economic data --

First, the Institute for Supply Management's service sector index surprised to the upside at 58.9 in November vs. 57.1 in October and the 55.5 market expectation. Employment was stable and new orders popped up a bit. Perhaps most importantly, the priced paid sub-index jumped to 55.6 from 51.9. It's still a lot lower than it was earlier this year. But that's quite a one-month jump.

Second, factory orders plunged 4.7% in October. That was the biggest drop in more than six years and worse than the 4% forecast. Orders outside of transportation fell 0.8%.

I'd call this a mixed bag of data. But I'd watch the bonds closely. Treasuries have been on a one-way rocket ride higher in price, lower in yield. This is basically a recession or near-recession bet. IF we see more signs that inflation is not yet dead (like this prices paid index ... like the surge in gold ... like the bottoming action in oil prices, etc.) -- AND we fail to get even worse economic data -- you could see bonds roll over, or at least correct. Just something to keep an eye on.

Monday, December 04, 2006

Fed data: Delinquencies on the rise

Every quarter, the Federal Reserve releases data on loan delinquencies (defined as loans that are at least 30 days past due) and charge-offs. Q3 figures were just released today. Surprise, surprise: Late payments on real estate loans are on the rise.

The delinquency rate for all RE loans jumped to 1.47% in Q3 from 1.38% in Q2. That's the highest since Q2 2004. The residential RE delinquency rate jumped to 1.72%, the highest since Q4 2003, while commercial RE delinquencies were only 1.10%, the highest since Q1 2005.

It's important to note that these deliquency rates are VERY low historically. But the trend is clear -- toward higher DQ rates. All the easy money/Frankenstein Financing handed out during the housing bubble is coming back to bite lenders. The only question is, "How severe will the fallout be?"

Delinquency rates for most other loan categories (agricultural, commercial & industrial, etc.) remain low, though credit card DQs are picking up. Charge-offs remain low, but they lag DQs by a few months (you have to miss a payment first, then the bank tries to get you caught back up, THEN they charge off the loan as uncollectable)

Pending home sales sink ...

The National Association of Realtors just released pending home sales figures for October. These figures are based on contract signings for existing homes, vs. the normal sales figures, which are based on closings (for contracts signed 30-60 days prior). Therefore, they're more current/up-to-date.

In October, pending sales dropped 1.7%, more than triple the 0.5% decrease forecast by economists. The decline follows a 1.1% drop in September. Pendings are down 12.3% year-over-year.

Friday, December 01, 2006

Latest Pimco rumination worth a read

You've probably heard of Pimco, the mega-bond fund management shop headed by Bill Gross. Gross has years and years of experience in fixed income management and knows more about bonds than I ever will. Anyway, his latest monthly commentary is well worth a read, in my book. He focuses on risk spreads, or the amount of excess yield offered on corporate debt securities above and beyond yields on risk-free Treasuries. His argument in a nutshell: That they've compressed to unbelievably tight levels and can't go much further.

I think Gross is spot on. Despite the evident housing bust ... despite worsening economic news ... and despite the deepest yield curve inversion we've seen since just before the 2001 recession, risk spreads have continued to contract. At the same time, stocks have gone up virtually every day and the VIX, a measure of investor complacency, has tanked.

This simply doesn't make sense. One or more of these markets has to be "wrong." Either we're going to have a hard landing (meaning the Treasury market is "right," we're going into a recession, and risky bonds and stocks are "wrong"). Or we're going to find an economic bottom very soon and see much better growth and credit conditions in 2007 (meaning Treasuries are "wrong" and risky bonds and stocks are "right").

Personally, I think this economy is in more trouble than people realize and that credit spreads are way, way too tight. It's nice to have Gross, more or less, on my side!

Worst construction drop since 9/11 ... Ugly ISM data ... and more

We got another pair of lousy economic reports this morning -- the Institute for Supply Management's manufacturing index dropped to 49.5 in November from 51.2 in October. We haven't seen a reading below 50, indicating a contraction in the sector, since April 2003 (right after the Iraq War began). Moreover, construction spending dropped 1% in the month of October. We haven't seen a monthly decline of that magnitude since -- get this -- the month of 9/11, when it was also a 1% drop.

We all know housing stinks, so it's no surprise that residential construction spending fell 1.9%. But what I find interesting is that NONRESIDENTIAL spending is also slipping. There was no change in nonresidential spending in October, and a 0.2% drop in September. As recently as this summer, we were seeing consistent monthly gains over 1%.

The market reaction: More of the same -- the dollar is getting pounded (and euro-ed, and yen-ed), with the Dollar Index recently down 29 basis points. Ten-year Treasury yields are down by just over 3 basis points.

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