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Wednesday, February 6, 2008

Housing/Subprime Roundup — Feb. 6, 2008

Items of interest:

U.S. MBA's Mortgage Applications Index Rose 3% Last Week -- Mortgage applications in the U.S. increased for a fifth consecutive week, led by a rebound in purchases.

The Mortgage Bankers Association's index of applications to buy a home or refinance a loan rose 3 percent last week to 1086.6, the highest since March 2004. The group's purchase index jumped 12 percent and the refinancing gauge fell from a four- year high.

The collapse in the subprime market and tougher lending rules may be prompting borrowers to file multiple applications to ensure financing, economists said. Still, the decline in mortgage borrowing costs as the Federal Reserve has lowered rates may be making homes more affordable for some buyers. [...]

Mortgage fraud soared last year -- Mortgage fraud passed $4 billion in 2007, a dramatic increase from $1.6 billion in 2006, according to a report by MortgageDaily.com.

subprime writedownsUpdate: Wikipedia has the updated list of subprime losses to date. The rediff.com table is old and not accurate.

More overseas subprime pain -

rediff.com [India]:
Subprime pain: Who lost how much -- Four Indian banks -- State Bank of India, ICICI Bank, Bank of Baroda, and Bank of India too have big exposure to credit derivatives, with the spreads on these widening since international lenders turned risk-averse following the crisis in the US subprime (or high-risk home loan) market. [...]

ICICI Bank has the highest exposure of $1.5 billion. SBI has an estimated exposure of $1 billion, BoI of $300 million, and BoB of $150 million. About 5-10 per cent of this figure could be the losses that these banks could incur. [...]
Bloomberg: U.S. Contagion Is a Fast-Growing Danger for Asia
The New Yorker:
Bonds Unbound -- The latest looming crisis is the possible implosion of a group of companies called monoline insurers. If you haven’t heard of monoline insurers, don’t worry: until recently, few people, even on Wall Street, were all that interested in them. Yet their problems have become a serious threat to global markets. Rumors that monoline insurers, like M.B.I.A. and Ambac, were in serious trouble helped spark the vast market sell-off that prompted the Federal Reserve’s interest-rate cut two weeks ago, and, only a few days later, rumors of a government-orchestrated bailout of these companies set off a six-hundred-point rally in the Dow.

Monoline insurers do a straightforward job: they insure securities—guaranteeing, for instance, that if a bond defaults they’ll cover the interest and the principal. Historically, this was a fairly sleepy business [...]

a peculiar feature of bond insurance: insurers’ credit ratings get automatically applied to any bond they insure. M.B.I.A. and Ambac have enjoyed the highest rating possible, AAA. As a result, any bond they insured, no matter how junky, became an AAA security, which meant access to more investors and a generally lower interest rate. The problem is that this process works in reverse, too. If the insurers lose their AAA ratings—credit agencies have made clear that both companies are at risk of this, and one agency has already downgraded Ambac to AA—then the bonds they’ve insured will lose their ratings as well, which will leave investors holding billions upon billions in assets worth a lot less than they thought. That’s why so many people on Wall Street are pushing for a bailout for the insurers. It may be an abandonment of free-market principles, but no one has ever accused the Street of putting principle above profit. [...]
CDO Ratings to Fall as Losses Trigger Fitch Overhaul -- Fitch Ratings may downgrade the $220 billion of collateralized debt obligations it assesses that are based on corporate securities to reflect higher risks of default than the firm initially assumed.

The New York-based company may lower the notes by as much as five levels after failing to accurately assess the risk of debt that packages other assets, according to guidelines proposed by Fitch today. CDOs with AAA grades that are based on credit- default swaps and aren't actively managed may face the steepest reductions.

Fitch, Moody's Investors Service and Standard & Poor's are slashing ratings amid criticism that they failed to react quickly enough as rising defaults on subprime mortgages in the U.S. caused a plunge in the value of CDOs linked to home loans. Fitch, a unit of Fimalac SA in Paris, cut $67 billion of mortgage-linked CDOs in November, lowering some AAA debt to below investment grade.

``Fitch is acknowledging that it was overly optimistic in its default rate and other assumptions in its original CDO methodology,'' said Christian Stracke, an analyst at bond research firm CreditSights Inc. in London.

Moody's last year reduced $76 billion of CDOs and began this year with $185 billion of deals under review. [...]
Calculated Risk: Fitch Takes Rating Actions on 172,326 Bonds
Calculated Risk: CDO Market Almost Frozen

The Big Picture:

I'm thinking waterboarding the entire staff is the way to go with these criminal idiots [...]
Flashback 3 years. Many people saw the problems with financial derivatives like CDO's. Here's a Financial Times article critical of them from April 19, 2005:
Gillean Tett / Financial Times:
CDO's have deepened the asset pool for investors but clouds may be gathering -- Innovative ways to repackage debt and spread risk have brought higher returns but have yet to be tested through a full credit cycle. Not everyone believes buyers are fully aware of the potential downside, writes Gillian Tett

A few months ago Ian Sideris,a partner at Simmons & Simmons law firm, was completing a contract for a collateralised debt obligation when he asked a delicate question: who was the investor buying this CDO, a complex instrument that allows investors to buy pools of debt? The answer took him aback.

Rather than a hedge fund or bank, as Mr Simkins had expected, the client was an Australian charity. "We need to realise that the universe of investors for this type of product has widened in the last year," he says. "But then you also have to wonder about the capacity of some of these new investors to understand the economics [of what they are buying]."

It is a question regulators might also ask, as credit markets have this year started to wobble. Just 10 years ago, the concept of CDOs barely existed in the financial world. Even now, the sector is so murky that many non-bankers would struggle to define exactly what they are. Still, last year alone, the value of all CDOs issued and sold to investors reached $120bn (£63bn, €92bn), according to Thomson Financial (although JP Morgan thinks the total was $366bn if both cash and derivatives in these instruments is included). That lower figure is nearly equivalent to all European corporate bond issuance in 2004. [...]

Risks can defy expectations

. . . striking research by Gary Jenkins, an analyst at Deutsche Bank who has looked at corporate bond spreads - that is, the difference between a bond's yield and the yield of a US Treasury bond - since 1926.

Mr Jenkins discovered that in any single year spreads on Baa-rated bonds were most likely to move less than 10 basis points. However, the second most common event was that bonds moved by 100 basis points or more.

The moral? Though financial markets are often stable, when turbulence strikes, it can hit with unexpected vengeance. "Investors are always surprised by this - but they shouldn't be if they look at history," Mr Jenkins notes.

It is a point of considerable importance for collateralised debt obligations (CDOs). One of the most crucial questions in this fast-growing market is whether investors correctly understand "correlation" risk - that is, the danger that if one asset turns bad it could affect other assets in a snowball effect. [...]
Market Oracle:
Hedge Funds and CDO Investment Landfills: How professionals dump their toxic waste on you
declining markets real estate mapBlown Mortgage blog:
All Real Estate is Local - You Could be Less Screwed than Others -- About a week ago (on my birthday no less) Countrywide sent out a list of Soft Markets (Countrywide Soft Markets, PDF - 22 pages) across the country rated from 5 (the worst devaluation in property value) to 1 (less devaluation). [...]

I recommend having a look at this soft market list if you are considering purchasing a home so that you can get more insight in to that particular area above and beyond the “all real estate is local” smokescreen bandied about by your hometown Realtor. [...]
Wall Street Journal:
Housing Slump Puts New Homes on a Diet -- In Tampa, where the average home size ballooned from 1,400 square feet 35 years ago to approximately 2,400 square feet in 2006, houses are getting smaller, according to James Thorner of the St. Petersburg Times. Faced with hesitant buyers and a tighter credit market, builders like KB Home are scaling down to produce residences that buyers can afford.

KB Home, whose average home size was 2,200 square feet in Tampa in 2006, is now down to 1,800, the Times says. [...]

Calculated Risk

MishTalk - Mike Shedlock

Paul Krugman - NY Times

The Big Picture - Barry Ritholtz

naked capitalism - Yves Smith

Pragmatic Capitalism

Washington's Blog

Safe Haven

Paper Economy

The Daily Reckoning - Australia