You Know the Saying, "Celebrities Always Die in Threes"? Banks Always Fail in Hundreds.

A bank failure - particularly the failure of a large bank for reasons that are not idiosyncratic - should sound alarm bells in the brain of anyone who knows the statistical distribution of bank failures.



Prediction: the chart will soon have another spike of bank failures.

One other observation: the FDIC is going to use up a huge chunk of its capital paying IndyMac claims. Expect them to raise deposit insurance premiums for other banks. This means even lower profits for banks.

FDIC Comments Imply a Big Haircut for IndyMac's Loans

The following items are from this WSJ article about the IndyMac failure:

• IndyMac had roughly $19 billion of deposits. Nearly $1 billion of those deposits were uninsured, affecting about 10,000 people, the FDIC said.
• The Pasadena, Calif., thrift was one of the largest savings and loans in the country, with about $32 billion in assets.
• The collapse is expected to cost the Federal Deposit Insurance Corp. between $4 billion and $8 billion, potentially wiping out more than 10% of the FDIC's $53 billion deposit-insurance fund.

We know from a recent Reuters article how big IndyMac's Federal Home Loan Bank advances were: "The loans, or "advances" -- totaling more than $10 billion as of March 31 by the San Francisco FHLB -- are backed by mortgages pledged by IndyMac."

We also know that "the FHLBs have a 'super lien' when institutions fail. To protect their position they have a claim on any of the additional eligible collateral in the failed bank. In addition, the FDIC has a regulation that reaffirms the FHLBs priority and the FHLBs can demand prepayment of advances when institutions fail."

Using what we know, we can infer the percentage haircut that the FDIC is placing on Indymac's assets. It's not pretty:


Now we see that these assets are every bit as bad as bearish bloggers have been saying.

Now we see that there is not a "liquidity crisis" or a "subprime crisis", but a housing crash and a solvency crisis.

The Walking Away Trade

Some Buy a New Home to Bail on the Old
Wall Street Journal, June 11, 2008; Page A3

Meanwhile, Mr. Hawks, the Las Vegas broker, says he receives one to two dozen inquiries every week from individuals inquiring about a buy-and-bail. "People are starting to ask how much their good credit is worth," particularly when their home is underwater by hundreds of thousands of dollars.

Defaults on privately insured U.S. mortgages rose in February

NEW YORK, March 31 (Reuters)

Defaults on privately insured U.S. mortgages rose 38.1 percent in February, as a growing number of homeowners failed to keep up with their loan payments.

The Mortgage Insurance Cos of America on Monday said 60,911 insured borrowers were at least 60 days late on payments in February. That is up from 44,111 a year earlier, but down 11.7 percent from January's record 68,950.

On March 27, Radian Group Inc (RDN.N: Quote, Profile, Research), one of the largest mortgage insurers, said its main unit would no longer insure home loans where borrowers cannot document income or assets, citing the loans' "poor performance."

I had to double check the dateline. That should have been written in March 2007. Talk about slow learners!

Stop the Housing Bailout

People are getting organized to Stop The [incipient] Housing Bailout. Here's an email I got yesterday:

"We have created a website www.StopTheHousingBailout.com (currently hosted on NationalBubble) that is designed to be a clearinghouse of information for a movement against the bailout. The website is in its infancy, but currently consists of a statement why the bailout is wrong and several links to efforts to stop the bailout."

I don't think the Federal Government can afford to bail out the housing crash - it is too big - but that doesn't mean they won't try.

Buyers' Revenge: Trash the House After Foreclosure

In today's Wall Street Journal, an article pertaining to loss severity: Buyers' Revenge: Trash the House After Foreclosure.

Vandals who break into empty houses often smash windows and paint graffiti on the walls, he says. But it takes an enraged, delinquent mortgagor to indulge in a frenzy of destruction, such as the one that took place recently in a three-bedroom, 1,949-square-foot house in a residential and industrial area northeast of the casinos on the Strip.

Light switches, outlet covers and thermostats were smashed. There was what looked to be crowbar damage along the staircase. A large pool of paint had hardened on the living-room carpet. It appeared that someone had dripped motor oil in a trail that wound its way through every carpeted room. The appliances were gone, as were most light fixtures. A cabinet door had been removed and left soaking in a full tub of water. Not a wall was left without a hole the diameter of a closet rod, including the pink child's room once carefully decorated with a floral wallpaper stripe. It's damage that Mr. Carver described as "a vengeance-type thing."

This is a phenomenon that we first observed a year ago. Another important principle regarding loss severity: default rates and recovery rates are inversely correlated.

Shiller on Long Term Home Prices

Here's an amazing chart from a Robert Shiller paper (Long-Term Perspectives on the Current Boom in Home Prices) that has been making the rounds.

This is a chart of real home price indexes for the U.S. 1890-2005, Amsterdam 1628-1973, and Norway 1819-1989.

Note that the price indexes for Amsterdam and Norway end well before the U.S. data series, and so their current real estate bubbles not visible in the chart.

Wednesday Interesting Articles

Real interest rates are now negative [Mankiw].

"Nothing in economic theory precludes negative real interest rates, or even suggests they should be anomalous. Nominal interest rates cannot be negative, because people would just hold cash instead of bonds,* but real interest rates can be negative. If real interest rates were very negative, investors could start investing in inventories of goods, but this arbitrage is not easy. Storing goods is costly, and many things in the CPI basket, such as services, are not storable at all.

In standard models of asset pricing, negative real interest rates are most likely to arise if growth expectations are particularly low or if uncertainty is particularly high."

Amit has a new post up about Downey [Kinnaras Capital Blog].

"...as we've covered, DSL's balance sheet greatly overstates its credit quality by ignoring market prices for the homes these mortgages are secured against. Based on Table II, there's about $2B in "extra" collateral value that DSL is implying its loans are secured against when market prices are much lower. NPAs are rapidly accelerating and the bank is facing a very challenging recast schedule. All of these obstacles are stacked against just $1.3B in capital which is why I've maintained my puts against DSL."

Collection of bearish data from [Mish's Global Economic Trend Analysis].

End of Month Desk Clearing Time

Berkshire has released Buffett's shareholder letter for 2007. A couple interesting points:

• "In 2002 when the Euro averaged 94.6¢, our trade deficit with Germany (the fifth largest of our trading partners) was $36 billion, whereas in 2007, with the Euro averaging $1.37, our deficit with Germany was up to $45 billion. Similarly, the Canadian dollar averaged 64¢ in 2002 and 93¢ in 2007. Yet our trade deficit with Canada rose as well, from $50 billion in 2002 to $64 billion in 2007. So far, at least, a plunging dollar has not done much to bring our trade activity into balance."
• "Whatever pension-cost surprises are in store for shareholders down the road, these jolts will besurpassed many times over by those experienced by taxpayers. Public pension promises are huge and, in many cases, funding is woefully inadequate."

Some older items from my inbox:

"...private-jet demand generally lags GDP by two to three quarters. So if we’re in a recession in the first quarter, the jet market will slow in the third or fourth quarter. But Mr. Duckson is already seeing a growing supply of mid-size older jets, which is notable given that inventories of used jets have been slim for the past two years. 'The old, mid-size jets are the part of the market that usually sees a drop first,' he says."

Retailers Taking Their Medicine and Turning Cautious Over Growth:

Announcements over the last couple months include Movie Gallery closing another 400 stores... Starbucks closing 100 stores and slowing expansion plans by 34%; Ann Taylor shuttering 117 stores... Sprint Nextel closing 125 stores... Cost Plus World Market closing 18 stores; Liz Claiborne closing 54 Sigrid Olsen stores; New York & Company axing the Jasmine Sola brand and its 32 stores; Ethan Allen closing 12 stores; PacSun closing all of its 173 demo stores; and Talbots exiting its kids and men's lines through closure of 78 stores... Macy's closing nine stores; ...Rent-A-Center closing 280 stores; Sofa Express closing 44 stores in bankruptcy;

From Mish's Changing Social Attitudes About Debt:

Remember the catchphrase "throwing away money on rent"? The bottom will come when people start bragging about the day they stopped "throwing away money on an overpriced house". That's a long ways away from here in terms of both price and time...

The secular trend towards consumption has peaked.

A year ago only fools saved money. Saving money is becoming more socially acceptable with each passing day. Eventually it will be embraced.

This is from a Calculated Risk post on the JP Morgan conference call:

James Dimon:
This is a lesson that's been learned over and over about broker originations, they perform much worse than our own originations, and if you separate home equity into we call it kind of good bank, bad bank, and broker so I would say it's less than 20%, but a lot of the losses are coming from that 20%, which is high LTV, broker originated businesses. High LTV business is also bad in its own.

Analyst:
And the 20% you referred to a minute ago in round numbers is the sort of specifically high LTV and originated away [by brokers] is that right?

James Dimon:
It's been very consistent In both our own originated and broker originated, high LTV, stated income is bad. It is three times worse in broker than it is in our own.

Analyst:
Wow.

Wow indeed. Guess who has a lot of broker originated, high LTV, stated income loans?

Harley-Davidson also appeared eager to extend easier credit.

In a loan-securitization filing last August, Harley-Davidson said 42.9% of the loans it was selling in the securitization trust had zero down payment, which is double the level of zero down-payment loans recorded for securitizations done in 2006.

Disclosure: short M and DSL

January Survey of Downey Financial (DSL) Defaults and Trustee's Sales

Today I updated my Downey Financial (DSL) survey of defaults and trustee's sales for January 2008. It's based on a sample of San Diego, San Joaquin, and Solano counties only. See the footnote for more on how this data is collected. (1).



I was waiting to see whether the jump in December was just an aberration related to the end of the year. Nope! Looks to me like a runaway train of defaulting borrowers.

This suggests that the Downey 8-K (which should come out in two weeks) will once again show massively higher non-performing assets.



(1) Not all counties make this data easily available online (especially in California). Los Angeles does not provide online access, and many of the counties that do have extremely cumbersome interfaces. My surveying method is to count all of the default notices and all of the notices of trustee's sale and trustee deeds during the time period. I do not make any adjustments for notices of rescission of default. I have found this data to be an excellent leading indicator, but no warranty is made as to its accuracy.

Disclosure: Own DSL Puts.

You Walk Away

What do you do if you are underwater on your house? You walk away.

1. We will stop your mortgage company from calling you.
2. You will immediately know the exact amount of days you have to live in your house payment free. ... We also will notify you if the lender is taking longer than expected subsequently giving you more time in your home payment free.
3. You will be enrolled in our affiliate credit repair plan. They have removed thousands of foreclosures from their clients credit reports.
4. You get a personal consultation with one of our highly experienced Real Estate Attorneys making sure the lender followed the law perfectly. If they did not, you may have a case against them.

It's about to become "acceptable" to stop paying your mortgage simply because you are underwater.

People are going to realize that they can sell their credit score in exchange for their mortgage balance. It will be the trade of a lifetime for millions of people.

Floyd Norris: A Bear's Questions

From a Floyd Norris post called A Bear’s Questions comes an excellent quote from David A. Rosenberg, a Merrill Lynch economist:

Finally, the question must be asked: if the first 7 percent downleg in home prices could manage to trigger …
1. Almost $100 billion in write-downs in the banking sector;
2. A 65 percent year-over-year surge in foreclosures;
3. The highest residential real estate loan delinquency rate in 20 years; and,
4. A 20 percent plunge in S&P financials …
… then what, pray tell, will the next 20-30 percent have in store?

I think this is dead on. There are tons of people out there catching falling knives.

I added new shorts since January 1 as a recession play: HOG, M, F, TIF, CROX. Short the consumer and long SHY and BIL is a great trade in my book.

Are Financials a Good Buy Yet?

I think this WSJ article answers that question.

Warren Buffett agreed to pay $4.5 billion to buy the majority of an industrial conglomerate from Chicago's Pritzker family, choosing to invest in products like plumbing pipes and railroad tank cars as Asian investors pour billions into U.S. financial institutions.

Who is the smart money?

With more than $45 billion in cash on its balance sheet and a triple-A credit rating, Berkshire could easily buy a stake in a big bank, brokerage or other hard-hit financial firm. But so far, Asian and Middle Eastern investors have been at the forefront of financial deals.

The Marmon investment doesn't mean Mr. Buffett has written off the U.S. financial industry. As he did with high-yield telecom bonds several years ago, Mr. Buffett typically waits until prices fall to rock-bottom levels and until few other buyers are on the hunt.

Sea Change in California REO Pricing

This is a bad sign for loss severity at our California Savings and Loans:

Banks and other mortgage lenders are starting to deeply discount their “owned” properties – the homes they have foreclosed on – says a report Thursday from ForeclosureRadar...

“A notable sea change occurred in November. Lenders are starting to aggressively discount properties” says ForeclosureRadar founder Sean O’Toole. “We were surprised by the magnitude of the discount and even more surprised that most of the homes went back to the bank with no investor bidding in spite of the price cut.”

In one example cited by ForeclosureRadar, 8215 Shay Circle in Stockton, purchased new in January 2006 for $481,000, saw a precipitous decline in price. The loan defaulted in 2007 and the lender discounted the opening bid at auction in November to $240,000. But even then the home went back to the bank with no investor bids, the report says.

Here is some Credit Bubble Stocks background on default rates and loss severity.

Investors are increasingly walking away from houses:

“More than one-fifth of 6,557 Bay Area properties that fell into foreclosure from January through September this year were owned by investors, according to a Chronicle analysis of public records compiled by DataQuick. Of properties repossessed by lenders, 1 in 6 had been owned by people who had two or more foreclosures in their names. Eighteen Bay Area investors had five or more foreclosures.”

Why I'm Not Covering

Another violent bear market rally. The market should have tanked instead after the awful news this week:

• Citadel bought a portfolio of E*Trade's residential loans. "Citigroup investment bank analyst Prashant Bhatia said E*Trade actually received 11 cents on the dollar for its portfolio, if you factor in that the brokerage received $800 million in cash minus 85 million shares it issued."
  
• E*Trade operated a bank, and these were relatively high quality loans. "...73 percent of the assets were backed by prime mortgages, or loans to people with solid credit." Downey and BankUnited have arguably lower quality loans, but the market is pricing them much higher than what E*Trade sold their loans for.
  
• Florida municipalities invest cash in a state-run investment pool. It seems that they were invested in low quality securities, and now Florida Halts Withdrawals From Local Investment Fund. There was a run on the fund, and some lucky cities got out in time. But not Jefferson County - their CFO says "I might not be able to pay our employees tomorrow."
• The Treasury's scheme to have lenders restructure loans has been on the news constantly. Russ Winter points out:
  
• "How exactly does the New Hope Alliance secure the agreement of ten or fifteen MBS holders to lower coupons and terms. ... Credit insurance is also put on against default and against altered conditions. If somehow some MBS were restructured under new terms this would in turn trigger a wave of claims against the credit insurance written against this securities. Would the insurers (if even still around) agree to pay these claims? This scheme as it applies to the mountain of MBS in the marketplace is just too much of a tangled web to ever be seriously implemented."

Ever calm and rational, Gary North wrote a good explanation of the rally:

On Tuesday, November 27, the Dow Jones Industrial Average rose by 215 points. The next day, it rose by 330 points.

Why? ... The news had broken that morning of the offer by the government of Abu Dhabi to pay $7.5 billion for 4.9% of America's largest and most prestigious bank, Citigroup.

The stock fund managers started buying as soon as the news hit. The official interpretation: "This decision by Abu Dhabi indicates that America's largest bank is in good shape. This is the end of the subprime crisis."

Here is my interpretation: A small percentage of a gigantic pool of oil-generated capital, which is managed by government bureaucrats in a city-state whose nation did not exist as recently as 1970, was used to buy 4.9% of the largest bank in the United States because this purchase was perceived as a better deal than buying T-bills denominated in a falling dollar.

Another reason for the rally is the eager anticipation of another cut in the Fed Funds rate. Bespoke did a post showing the reaction of various sectors to the last three Federal Reserve interventions in our markets:

Oops! Similar results in the homebuilding sector, of course. Rate cuts aren't going to keep the lights on if you're a real business that made bad investment decisions.

I put together a chart showing the performance of the Credit Bubble Stocks from this blog. Each data series begins on the date the stock was first mentioned on the blog.

(Click for larger version.)
S&P and cash are included for comparison.
You can see that Fed interventions and mistaken bullishness have caused sharp rallies, but they are fleeting and reality quickly catches up with the market.

David Einhorn on Credit

David Einhorn's remarks from the 17th annual Graham & Dodd Breakfast. It's a must read but here are some quotes:

"[The] fear [among banks, brokerages, and hedge funds] is that the new prices [for mortgage-backed securities and other convoluted structures] are actually disclosed. This is the 'don't-ask, don't-tell method' of security valuation."

"...lenders of all sorts have lent too much money and did not demand enough interest to compensate them for the risks they took. There has been a colossal undercharging for credit across the board."

"Loans [were] based on the borrowers' ability to refinance rather than the borrowers' ability to repay."

"Advocates of securitization say it disperses risk. However, it does so by separating the loan originator from the eventual outcome of the loan."