Side effects to financial medicine

Writing in the San Francisco Chronicle, Kathleen Pender argues that the experiments currently being conducted by the federal government to rescue the financial markets aren't immune to their own -- and often unforeseen -- perils. In other words, like drugs, there could be side effects:

It would be nice if the federal government would fess up about the potential side effects of the medicine it has been delivering in increasing doses to the financial markets.

That might be hard to do, considering that most of these experimental remedies are being invented on the spot and unleashed on the market without a bit of the rigorous testing required of new drugs.

But make no mistake: If the feds succeed in preventing a financial collapse, there will be a price to pay...

Economists say they are likely to include some combination of higher taxes, higher interest rates, higher inflation, slower economic growth and a weaker dollar.

Let's remember for a moment what got us into this predicament.

After the stock market crash in 2000 and the terrorist attacks in 2001, the Federal Reserve kept interest rates too low for too long. The federal funds rate stayed at 1 percent throughout 2003, long after the 2001 recession had ended.

Low rates fueled speculation in housing and the creation of new mortgages and mortgage-backed securities that were sloppily underwritten, poorly rated and widely misunderstood. Hedge funds and other investors used these securities to borrow money to buy other assets, creating a mountain of debt atop a small slice of fragile collateral.

Banking regulators, Congress or the Bush administration could have stepped in to restore some sanity to the markets but declined to do so in the name of homeownership and free enterprise...

"We are going to nationalize the mortgage market," says Ken Rosen, chairman of the Fisher Center for Real Estate at UC Berkeley, consultant and hedge fund manager. "It's the outcome of not regulating at the right time."

Economists say they are likely to include some combination of higher taxes, higher interest rates, higher inflation, slower economic growth and a weaker dollar.

As much as he dislikes it, Rosen says, it's the right thing to do in the short run. "If they did not stop the credit crisis, we would have something much worse - a meltdown like we had in the '30s," he says. But "it's not a good thing in the long run."

Rosen predicts that when all is said and done, there could be as much as $1 trillion worth of losses in the financial system. He predicts that investors will bear 60 percent of the losses and the government could shoulder the rest...

To pay for these losses, the government will have to raise taxes, sell more debt or both.

Near term, Rosen predicts that the Fed will have to keep cutting interest rates to prevent further weakness in housing and the economy. That will put further downward pressure on the dollar. A falling dollar will fuel inflation because imports, oil and other commodities will cost more.

Long term, the government will have to raise interest rates to entice foreigners to buy our debt.

Moving closer towards a government bailout of the housing market

Opponents of a housing/mortgage bailout -- which currently includes the Bush Administration -- talk of a 'moral hazard' that will reward scofflaws (lenders) and opportunists (speculators) who should realize the consequences of their actions.

But I would argue that the reason that the federal government will eventually have to step in with a rescue plan is because it was its own failings during the boom itself -- such as weak oversight and an arrogant refusal to listen to bloggers and economists warning against a financial catastrophe -- that allowed things to get so out of control. And, for better or worse, we have to accept the actions of a government that we elect, because crying now about bailouts is simply way too late. The chorus against a future government bailout would have made a lot more sense back in 2003 when the boom was just starting. So who failed the public -- the media, government, greedy lenders or uninformed borrowers? All of the above. That's why the problem is simply too big to ignore.

From an L.A. Times story:

From Wall Street to Capitol Hill, calls are growing for the government to get into the mortgage business as the only way out of the housing crisis roiling the economy and the financial markets.

Proposals to shore up tottering home loans with taxpayer money are gaining traction in Congress and moving to the forefront of presidential politics...

But while the Fed can help lenders and the investment industry, it has little authority to help individual borrowers or to force their lenders to modify repayment terms so that strapped borrowers can stay in their homes. That is putting pressure on Congress to step into the breach...

Thus far the Bush administration has resisted anything that resembles a taxpayer- financed homeowner bailout. Instead, it has placed its faith into several programs that encourage lenders and distressed homeowners to work things out voluntarily.

And Treasury Secretary Henry M. Paulson Jr., former chief executive of investment bank Goldman, Sachs & Co., has said he believes the housing bubble should be allowed to work itself out naturally.

Critics say that's tantamount to bailing out the big players while throwing the little guys to the wolves, and that a more evenhanded approach will make any government action more broadly palatable...

Still, a homeowner "bailout" could be a political minefield. Any relief program will have to be carefully fashioned to focus only on deserving homeowners whose financial ills are no fault of their own. Otherwise, the program could face a backlash from voters who believe they played by the rules only to have their tax money paid out to the imprudent or the crooked...

Others contend that what looks on the surface like a rescue of homeowners would really be a bailout of lenders who unscrupulously enticed borrowers into loans destined for trouble...

Some economists say the housing crisis is reaching such magnitude that it threatens to push the economy at large into a severe recession, a situation that would make the "moral hazard" debate seem irrelevant....

One way to balance government assistance to participants in the credit crisis -- whether it's branded a bailout or a rescue -- is to link it to tighter regulation of lenders and borrowers.

These can include strict capital requirements for investment banks that have accepted Fed money, underwriting standards for mortgages and consumer loans to prevent imprudent lending and borrowing, and mandated disclosures of the risks of various loans and bundled securities....

Among a number of rescue plans before Congress, perhaps the one with the most political clout behind it is a proposal sponsored by Rep. Barney Frank (D-Mass.), chairman of the House Financial Services Committee, and Sen. Christopher J. Dodd (D-Conn.), chairman of the Senate Banking Committee.

The Dodd-Frank plan would grant the Federal Housing Administration expanded powers to back the refinancing of troubled mortgages -- essentially taking the loans off the original lenders' hands -- by providing $300 billion in guarantees for new loans. Frank has scheduled a hearing on the bill for April 9.

The program would be directed at homes with values that have fallen below the balances due on their mortgages. These are the homes most likely to wind up in foreclosure.

Under the plan, the lender would be paid to surrender the mortgage -- but would get no more than 85% of the home's appraised value. The amount would be less than the value of the original mortgage, but presumably higher than what would be received if the bank were forced to reclaim and resell the property.

The borrower would get a new loan on terms that he or she could manage. The deal would be offered only on homes that are occupied by borrowers as their primary residence, which is designed to exclude speculators and vacation homes. If the home is sold within five years, moreover, the government would get a percentage of any profit to discourage "flipping." Frank's committee estimates that the program could refinance as many as 2 million homes.

Everybody benefits, Frank argued in an op-ed article for the Washington Post this month, when "a prudent write-down and appropriate refinancing" take the place of a foreclosure.

Another proposal, sponsored by Sen. Richard J. Durbin (D-Ill.), would change bankruptcy law to allow mortgage terms on primary residences to be altered by bankruptcy judges in individual cases. Currently, these are the only debts that remain outside a judge's jurisdiction.

Supporters of this plan contend that it would serve only homeowners unquestionably in distress because they would have to subject themselves to Chapter 13 bankruptcy to take advantage of its terms.

Looking for homeowners to interview who have used Props. 60, 90 or 110

I'm working on a story for the L.A. Times on the use of California Props. 60 and 90, which allow homeowners over age 55 a one-time opportunity to transfer their existing property tax base to a new property of the same or lesser value, and I'm looking for people to interview.

In the case of Prop. 60, the law covers property within the same county. In the case of Prop. 90, although the law in theory allows homeowners to transfer their existing tax base to another California county, since each county gets to choose if they want to participate, only a few actually do so (including several in Southern California).

But for those who want to use this law to move to the counties of Riverside (i.e., Palm Springs) or San Bernardino (i.e., the High Desert) or most of the Bay Area and Central California, they're out of luck. Consequently, I'm looking for people who would consider moving to these areas but haven't because they don't want their property taxes to rise exponentially.

Finally, Prop. 110 is similar to Prop. 60 but allows severely disabled people of any age to use this one-time opportunity to transfer their existing tax base within the same county, and I'll also be including that in the story.

If you'd like to get an idea of my writing style and how I cover subjects, click here for a story I wrote on reverse mortgages last month.

Please send any potential interview subjects to me directly at psduffy@sbcglobal.net.

Thanks!

Good credit may not be enough in "distressed" counties

Given the mortgage insurers' recent lending restrictions throughout California, good credit may not be enough for borrowers without a sufficient down payment or those looking to buy investment property or second homes. While that could push many buyers into the arms of the FHA, that program also has its own restrictions, and condo projects generally must be pre-approved by the agency.

First, from a story in the Daily Breeze:

Just when consumers and the U.S. economy need banks to lend more freely, the mortgage industry is making it harder to borrow - even for those with good credit.

In recent weeks, mortgage insurers, whose backing is required for borrowers who can't afford the traditional 20 percent down payment on a home, have already flagged nearly a quarter of the nation's ZIP codes where they refuse to insure some home loans.

That's more than 9,600 ZIP codes in at least 34 states where they won't insure certain types of home loans - those for investment properties or second homes, those with riskier adjustable-rate or interest-only mortgages, or for buyers making small down payments such as 3 percent.

Many mortgage insurers include the South Bay and much of California in a category known as "distressed market," where home values are expected to drop...

The reluctance to extend credit comes despite a flurry of government initiatives, including steady interest rate cuts by the Federal Reserve, intended to make it easier for would-be borrowers and those facing interest-rate resets on their mortgages.

The growing reluctance of lenders threatens to dampen sellers' already soggy prospects for the spring home-buying season - and that means more pain for the already battered housing sector and the broader economy.

The new restrictions will "severely limit the potential pool of buyers," whether the buyer plans to live in the home or rent it out, said Patrick Duffy, principal at MetroIntelligence Real Estate Advisors, a Los Angeles consulting firm.

"It could delay the rebound in the market," Duffy said. "It's going to force people to take longer to save up for the down payment."

While the South Bay will be affected by the reduced availability of mortgages, the area remains "a very popular area with a very high median income." That reality could insulate the South Bay from the worst effects of the tightening lending standards, Duffy said.

With banks and mortgage insurers pulling back, state and federal programs for first-time homebuyers and people with poor credit are attempting to fill the void.

"This is a great way to throw loans in the arms of the federal government," Duffy said. "FHA offers loans with only 3 percent down, and they just increased limits."...

Home buyers are adjusting to the new reality, Realtor Adolph James said.

"One of the things I've noticed is most of the people interested in purchasing property in the South Bay are bringing more money than they had in the past," said James, of Shorewood Realtors in Manhattan Beach.

"You're seeing fewer people coming with only 5 percent or 10 percent (as a down payment). The psyche is you can't come in with a shoestring because that's how people got in trouble."

Inland areas such as Harbor Gateway, which generally attract first-time homebuyers, are likely to feel the pain from the credit crunch more so than the beach cities, James said.

"That's where this stuff started and that's probably where it's going to end," James said. "You're going to see a few defaults in the beach areas, but nothing like what you're going to see in the entry-level areas."

Next, for an excellent overview of the pros and cons of FHA loans (as well as other timely posts), here's a summary from the SFVRealEstate blog, which is authored by Broker Associate Judy Graff and covers local and national topics for L.A.'s San Fernando Valley:

New FHA Loans: What You Need to Know

• New FHA restrictions just came out. Here’s the upside.
• The loan limits for SFR in L.A. are $729,750 (same as “jumbo conforming”).
• Loan limits for 2 units are $934,200.
• The interest rate is 6% as of this writing; however, there is mortgage insurance (see below).
• Minimum down payment is 3% (not including closing costs).
• Fixed rate and Adjustable rate programs are available.
• NO MINIMUM FICO REQUIREMENT (this is huge).
• Must be full documentation loan. No stated income loans.
• No buyer reserve requirement (this is also huge).
• No income limits.
• The seller can contribute up to 6%, including closing costs, although the seller does not have to pay the closing costs.
• There can be non-occupant co-signers on the loan.
• You do not have to be a first-time buyer.
• Gifts are permitted for the entire 3% borrower investment and don’t need to be “seasoned.”
• Gifts are also permitted for all closing costs & pre-paid items.
• Down payment assistance programs are permitted, such as city first-time buyer housing programs.

Now, here’s the downside:

• There is mortgage insurance. It equals either 0.5% point per month, or 1.5% points up front. The up-front payment is deductible from your taxes during the year that you buy.
• There are stricter appraisal requirements:
• Any operable or useful element in the subject property must have at least 2 or more years of useful life or it must be replaced.
• The appraiser must be FHA-approved.
• The appraiser can require a separate inspection upon any “visible” defect or if he/she has knowledge of any existing problem.
• The property must be structurally sound.
• It must have a useable garage.
• The property cannot have code violations.
• Each living unit much contain domestic hot water, sanitary facilities and a safe method of sewage disposal. Connection to public systems is required if available.
• Heating systems must be adequate for healthful and comfortable living conditions.
• Condo projects must be pre-approved; they can be spot-approved but this is much more difficult.
• Condo projects must have sufficient reserve funds.

Housing Chronicles to join new Forbes.com blog network

The Housing Chronicles Blog has been invited to join a new network soon to be launched by Forbes.com, the online website for Forbes magazine.

Entitled the Business and Financial Blog Network, although it will involve some targeted ads hosted by Forbes advertisers (which I promise to keep as unobtrusive as possible), the more important part of the deal will feature links from the various Forbes.com websites, which collectively rank among the most highly trafficked on the Internet (and ranking higher than the websites for Bloomberg, BusinessWeek, The Washington Post and the L.A. Times).

The network is expected to launch in the next 4-8 weeks and be officially announced next week.

Lenders restrict lending in 25% of country's zip codes

Reverting to standards last seen 20 years ago, lenders and private mortgage insurers have flagged about 25 percent of the country's zip codes as ineligible for loans on properties with less than 3% down payments as well as any investment properties, second homes or purchases made with adjustable rate loans. From an AP story via MSNBC:

Mortgage insurers, whose backing is required for borrowers who can’t afford the traditional 20 percent down payment on a home, have already flagged nearly a quarter of the nation’s ZIP codes where they refuse to insure some home loans... The entire states of California, Florida, Arizona, Michigan, Ohio and Nevada — which have seen the highest foreclosure rates and the worst price declines — are blackballed on some mortgage insurers’ lists.

Banks that have lost billions because of bad bets during the housing boom are now reverting to strict lending standards not seen in nearly 20 years, according to industry data and interviews with lenders.

For new home buyers and those seeking to refinance, it can mean higher down payments and a higher bar for credit scores, among other requirements. The toughest restrictions are in markets where home prices are falling, though regions where property values are rising are not immune...

The reluctance to extend credit comes despite a flurry of government initiatives, including steady interest rate cuts by the Federal Reserve, intended to make it easier for would-be borrowers and those facing interest-rate resets on their mortgages...

In recent weeks, mortgage insurers have flagged more than 9,600 ZIP codes in at least 34 states where they won’t insure certain types of home loans — those for investment properties or second homes, those with riskier adjustable-rate or interest-only mortgages, or for buyers making down payments of less than 3 percent.

With banks and mortgage insurers pulling back, state and federal programs for first-time buyers and people with poor credit are attempting to fill the void...

Amid the turmoil, the mortgage industry is playing hardball with borrowers.

Wells Fargo & Co. now requires a 25 percent down payment in the most distressed markets, according to a document sent to mortgage brokers last month. A company spokesman said in an e-mail message that Wells Fargo is “focused, as we’ve always been, on fair and responsible lending and sound credit risk management.”

Some borrowers who took out home-equity loans or second mortgages are being blocked from refinancing. The problem is most common among consumers using two different lenders.

Companies that made second mortgages are now denying requests — common in a refinancing transaction — to take secondary status in the event of a foreclosure. Especially in markets where prices are declining, holders of those loans want to be paid off before a loan is refinanced rather than take on the risk of default, industry experts say.

Lenders’ changes have removed 30 to 40 percent of the borrowers who could have qualified in recent years, estimated Tom LaMalfa, managing director at Wholesale Access, a Columbia, Md.-based mortgage research firm.

Lenders and mortgage insurers are also requiring proof of income and employment, something they didn’t always do during the housing boom.

Smaller builders getting increasingly squeezed by bank loans

A brother of mine who works with homebuilders as a subcontractor was telling me last night what a difficult time he's been having getting paid for work in the past -- sometimes as long ago as 2006, which certainly makes it difficult to pay his staff! So is this the behavior of insensitive companies or is something larger amiss -- such as a major cash squeeze which is impacting smaller builders even harder?

According to writer Michael Corkery in the Wall Street Journal -- who is an excellent writer covering the real estate beat -- what's happening now is the much-predicted 'second wave' of mortgage defaults now impacting the building community -- as well as the banks who funded their projects:

In the first wave of the housing crisis, homeowners across the U.S. lost their properties to foreclosure. Now, many of the nation's small and midsize home builders are on the ropes...

Now, plummeting home sales across the U.S. have left many builders with unsold inventory and land. Some are falling behind on interest payments, beginning to face foreclosures on developments...sometimes reaching into their own pocket to keep operations going. Many smaller builders financed their developments with so-called recourse debt, which means that if they default, banks could seize homes, cars and other personal assets.

The U.S. government is now scrambling to contain the damage from the housing market's unraveling. On Wednesday, federal regulators cleared the way for mortgage-finance giants Fannie Mae and Freddie Mac to inject as much as $200 billion into the mortgage market, a credit-boosting move that could help builders' flagging sales.

"There are a lot of companies on the brink" of bankruptcy, says Ricardo Chance, a managing director at KPMG Corporate Finance LLC, who is helping troubled builders in the Midwest, Northeast and Arizona restructure their businesses.

Builders' problems are now threatening losses for small and medium-size regional banks. Muscled out of the mortgage business by large national lenders, many of these banks flocked to construction lending as the housing market boomed. Though these institutions were generally less exposed to the subprime-backed securities that have generated billions of dollars in losses for national banks, they are the front-line casualties when builders and developers can't make their payments.

Delinquencies on loans to build single-family houses reached 7.5% of the value of all such loans in the fourth quarter, up from 2.1% a year earlier, according to Foresight Analytics, an economic and real-estate research firm. There's likely more pain ahead. The Commerce Department reported this week that permits for new housing construction, a barometer of future building activity, fell 7.8% in February to the lowest level in 16 years. Also this week, the Federal Deposit Insurance Corp. said it had "increased [its] overall concern" about banks with high concentrations of construction loans, particularly those for residential developments, its strongest warning to date about these banks...

Analysts say as many as 150 banks could fail over the next three years. By comparison, about 900 banks and savings-and-loans associations failed from 1990 to 1995, according to the FDIC...

Analysts worry that losses from home-construction loans could contribute to a possible credit squeeze in small towns and cities across the U.S. "You are going to see a contraction in lending not just for construction, but for auto loans and credit cards," says Gerard Cassidy, a banking analyst at RBC Capital Markets. "In our view, it's the big shoe to drop on the banking industry this year."...

Every housing downturn prompts some builders to go bust, but the current slump is sinking some seasoned companies..."Even rock-solid, generational businesses are taking desperate measures," says Jerry Howard, the chief executive of the National Association of Home Builders. While the industry group does not track bankruptcy filings by its members nationwide, its Atlanta affiliate estimates that as many as 20% of local builders are behind on interest payments...

These builders' struggles mean that when housing demand recovers, the industry could be more consolidated and dominated in many markets by large builders such as D.R. Horton Inc., Lennar Corp., Pulte Homes Inc., Centex Corp., KB Home and Toll Brothers Inc. While many of these publicly traded builders are coming under pressure from their banks amid a deepening credit squeeze, most have cash reserves that may give them an edge over smaller builders in renegotiating credit agreements with their lenders...

Not so for Whitlatch & Co., an Ohio builder profiled in detail for this story. If you have access to the Wall Street Journal, I highly recommend you read the article in its entirety, as it puts a face on a "greedy developer" who was anything but and the many steps he took to save his company, his employees and his investors.

L.A. price declines larger in cheaper, more outlying areas

Blogger Peter Viles at L.A. Land has compiled an interesting collection of stats on recent existing home activity for various zip codes in Los Angles County. His original theory was that more entry-level areas were taking a larger hit on prices, but I think it's more than just that -- some of these areas are also further out from employment centers, so it makes sense that the larger price declines would take place in places such as Palmdale and Lancaster. After all, if you could buy a home an newly affordable home in the San Fernando Valley, why would you commute further to the Santa Clarita or Antelope Valleys? For more central areas -- such as Reseda and Norwalk -- it's also the issue of the credit crunch impacting the availability of mortgages. Very interesting stats!

Here's the table he provided in his post:

Area/ZIP No. of sales Median Price decline from Feb. '07
Lancaster/93536 50 $258,000 -31.7%
Palmdale/93551 36 $308,000 -25.8%
Reseda/91335 35 $393,000 -26.0%
Norwalk/90650 30 $352,000 -27.8%
Lancaster/93535 29 $202,000 -36.0%
Long Beach/90808 27 $515,000 -8.0%
Altadena/91001 25 $549,000 -8.6%
Granada Hills/91344 24 $469,000 -23.4%
La Mirada/90638 23 $450,000 -16.7%
Lakewood/90712 23 $430,000 -19.9%
LA/Mar Vista/90066 22 $832,000 +0.8%
Lancaster/93534 22 $185,000 -36.2%
Northridge/91325 22 $565,000 -26.1%
Rancho P.V./90275 22 $1.11 Million +3.3%
North Hills/91343 21 $440,000 -21.4%
Palmdale/93552 21 $238,000 -33.9%
Canyon Country/91351 20 $405,000 -19.0%
Claremont/91711 20 $495,000 -16.2%
Pico Rivera/90660 20 $380,000 -20.3%

Below $300K: Avg. price change is -34.5%
$300K-$400K: Avg. price change is -26.8%
$400K-$600K: Avg. price change is -17.7%
$600K-$800K: No ZIPs with 20 or more sales
$800K and above: Avg. price change is +2.0%

Why another Great Depression is unlikely

With the housing bubble blogosphere abuzz lately with posts and comments predicting another Great Depression, L.A. Times writer Michael A. Hiltzik provides an excellent overview of how things are different this time around:

Dysfunctional capital markets, frantic central banks, stressed-out consumers, fear and uncertainty -- all are alarming echoes of the global economic cataclysm of the 1930s.

Which raises the inevitable question: Could another Great Depression be lurking over the horizon?...

On the surface, there are disquieting parallels between economic conditions in the early 1930s and those of today. There is the popping of enormous asset bubbles -- stocks then, housing now.

And, as in the Great Depression, the financial system is in disarray. It was symbolized back then by the failure of thousands of banks, mostly small, local outfits -- 2,300 in 1931 alone.The parallel today is the crippling ofonetime giantssuch as Bear Stearns Cos., Countrywide Financial Corp. and Ameriquest Mortgage Co.

Many economists believe that the U.S. will find it almost impossible to avert a recession, if one has not started already. Housing remains mired in a deep slump,with some analysts projecting that Southern California home values could plunge 40% from their peaks last year.The Commerce Department reported this week that new residential building permits nationwide plummeted 36.5% in February from a year earlier.

Then, like now, stock prices were highly volatile. The S&P 500 index, which fell more than 56% from 1928 through 1940, nevertheless recorded four up years in that span, including a 46.5% gain in 1933....

BUT

But there are vast differences between the 1930s and today. U.S. unemployment reached 25% during the Depression; last month it was reported at 4.8%. The international industrial economy was a shambles in the '30s. Today it is coming off a global boom....

Economists and historians say the most important difference between today's economic environment and the old days is the government's role.

"There's a perception now that you don't stand around at the central bank and whack people with a ruler for making bad decisions," said Robert Brusca, chief economist at New York-based Fact and Opinion Economics. "Instead, you do something."

Nothing demonstrates that as vividly as the Fed's orchestration of the takeover of Bear Stearns by JPMorgan Chase & Co. over the weekend. The deal staved off a possible Bear bankruptcy, which the central bank feared might traumatize financial systems worldwide.

The resolution drew a stark contrast with the Fed's role in the 1930 collapse of the Bank of the United States, a New York institution largely serving Jewish immigrants. The failure was then the largest in U.S. history, and the Fed's inability to arrange a rescue by Wall Street banks -- including J.P. Morgan & Co., the predecessor to the "white knight" in the Bear Stearns case -- caused a cataclysmic loss of confidence in the entire national banking system. That fueled a panic that historians regard as a key cause of the Depression.

The Fed's relative powerlessness in 1930 led directly to New Deal reforms that vastly expanded its authority. Some of the agency's new powers, such as its ability to lend directly to brokers and investment banks, were seldom or never used until the current crisis.

Fed Chairman Ben S. Bernanke, an expert in the central bank's Depression-era history, is also knowledgeable about the instruments at its disposal in a crisis...

But as Fed Vice Chairman Donald L. Kohn conceded in testimony before a Senate committee this month, the most serious challenges generally arise not from scenarios that can be forecast but from the unforeseen.

Alluding, in effect, to the tendency of regulated industries to burst at their weakest seams, Kohn blamed "the most sophisticated banks" for allowing credit rating agencies such as Moody's and Standard & Poor's to paper over the unsoundness of mortgage securities on their books.

The agencies bestowed lofty AAA ratings on some extremely complex mortgage bundles even though their inherent risks were not understood. The banks and firms that packaged the securities and hawked them to clients simply accepted the rating agencies' conclusions, which were often favorable to the packagers. The dubious valuations of many of these securities are at the core of the credit crisis roiling the financial markets today...

There are also limits to what monetary policy -- the Fed's responsibility -- can achieve on its own to forestall a drastic economic downturn. The Franklin D. Roosevelt administration not only reformed the Fed but also experimented with stimulative fiscal policy, such as unemployment relief.

New Deal programs aimed at staving off a wave of home foreclosures may be especially relevant today. Among the most important was the Home Owners Loan Corp., or HOLC, which is one of several models for homeowner relief being considered by Congress.

HOLC took over 1 million mortgages in default starting in 1933, worked to keep the owners in their homes and made new loans to strapped mortgage holders. When the agency was finally liquidated in 1951, it even returned a small profit to the U.S. Treasury.

So what next?

The Fed's recent actions were "a temporary palliative" to the fundamental problem in the economy, which is the rapid fall in home prices and its ripple effect on mortgage bonds and other securities, said Barry Eichengreen, a professor of economics and political science at UC Berkeley. "You have to reorganize the system, but the discussion about that has only begun."

CEO of homebuilder Standard Pacific retires

Home builder Standard Pacific, based in Orange County, has announced that CEO Steven Scarborough will be retiring, effectively immediately. The imperiled builder, which reported losses of $767 million last year, will be temporarily led by a member of the board of directors. From the Lansner on Real Estate blog at the Orange County Register:

The longtime chairman and CEO of Standard Pacific Corp. has retired — effective immediately — with a member of the board taking over the reins of the Irvine-based homebuilder in the midst of a housing slump that threatens the survival of many development firms.

Stephen J. Scarborough, the highest paid Orange County executive in 2004, is leaving the company after 27 years. He is being replaced by Jeffrey Peterson, a board member since 2001 and a former managing director at Trust Company of the West and Kidder, Peabody & Co.

In a conference call, Peterson declined to say whether the company is contemplating the filing of bankruptcy or to explain why Scarborough abruptly retired after seven years at the helm...

Although Peterson said the board has ordered management to act with “a sense of urgency,” company officials declined to say what, if any, conditions have changed to make such urgency necessary. Management could not have done a better job in addressing the challenges of the housing slump, said company chief financial officer Andy Parnes. But Parnes and Peterson would not say if conditions for Standard Pacific have deteriorated.

Affluent home owners also took out adjustable mortgages

For those who think that adjustable rate mortgages were taken out mostly by entry-level buyers, an article in the New York Times profiles more affluent borrowers -- those making more than $100,000 per year -- who have also been hit with re-setting rates that they find unaffordable:

They took out adjustable-rate mortgages at the peak of the housing bubble to buy homes they would otherwise not be able to afford. Or they refinanced existing mortgages to take cash out. And now, two or three years later, the day of reckoning is here.

These are not lower- and middle-income borrowers, but more affluent consumers with annual incomes of $100,000 or more who are increasingly being ensnared in the home mortgage crisis.

People in all income categories “are facing the shock of new payments that can be twice as much as previous ones,” said Susan M. Wachter, professor of business and a real estate specialist at the Wharton School of the University of Pennsylvania...

According to Loan Performance, a unit of First American CoreLogic, a real estate information company based in Santa Ana, Calif., about 870,000 borrowers took jumbo ARMs — mortgages of $417,000 or more — from 2005 to 2007.

In the fourth quarter of 2007, 8.10 percent were two or more payments late, it found, while 2.62 percent were in the foreclosure process and 1.35 percent had been foreclosed. All the numbers were up from the third quarter...

Today’s ARMs were “designed to fail, so you have to refinance,” Ms. Wachter said. “It shouldn’t be surprising that values go up and down in this kind of situation. And when you most need to refinance you can’t — the crux of the crunch.”

Jeffrey Conner, a San Francisco real estate lawyer, says he regularly hears from his clients “that lenders assured them they could always refinance.”

Refinancing requires some equity. Even if homeowners put a substantial amount of money down, many have no equity because their homes are worth less than they owe. In real estate parlance, their mortgages are under water.

Richard Geller, founder of Mortgage Relief Formula, a for-profit venture based in Fairfax, Va., that counsels troubled ARM borrowers, said he received calls from affluent consumers in almost every major metropolitan area...

Homeowners with at least 3 percent equity may qualify for refinancing through the Federal Housing Administration. On March 6, it began making loans up to $729,750, a new higher limit that expires Dec. 31 unless Congress extends it. Limits are 125 percent of median home prices, by county. Consumers can find their local limits at

https://entp.hud.gov/idapp/html/hicostlook.cfm.

To find a qualified lender or broker, consumers may call (800) CALL-FHA, look in the Yellow Pages or visit www.fha.gov for the four regional centers.

Loan modifications entail freezing or reducing interest rates and may also include balance reductions...

Negotiating a loan modification means understanding that in most cases “the lenders really don’t want to force people into foreclosure because that virtually guarantees large losses in the market,” said Dean Baker, an economist with the Center for Economic and Policy Research in Washington...

Borrowers should determine if they live in a state with nonrecourse laws. In general, lenders in those states cannot pursue borrowers for money owed. But these laws are complex and change often, so consulting with a lawyer may be necessary, Mr. Geller said. He has compiled a list of nonrecourse states at www.mortgagerelief formula.com/recourse.

USA Today's excellent real estate writer to head AP division

Although many elitists deride USA Today as a dumbed-down "McPaper," that's not really the case anymore; plus with 3 million subscribers it's far and away the largest daily paper in the country. Over the last couple of years, I've noticed the excellent reporting (and writing skills) of Noelle Knox for the housing and mortgage beat, whom I think made a point to be both fair and balanced in her reporting on a very complex subject.

I'm certainly not the only one to take notice; in fact, the Associated Press (AP) has brought Ms. Knox on board to create and lead their new AP Business: Real Estate & Home division. From a BusinessWire release:

The real estate and home service, called AP Business: Real Estate & Home, is the first targeted news product from AP's newly created Financial and Business News division. The division is responsible for AP's financial news coverage and for developing new content products to satisfy the needs of print, digital, broadcast and commercial customers. As Real Estate Editor, Knox, who has 18 years of business reporting experience, will help launch the service in the first half of the year.

This is certainly important news to the 1,500 newspapers which collectively own the AP, as they'll all be able to tap news stories, video and other media from this new division (something which I think is greatly needed at many local newspapers due to ongoing stresses in the industry and constant staff layoffs). Even better -- she'll be objective!

The creation of a new real estate and home news service is part of the AP 2.0 corporate strategy focusing on financial news, entertainment and sports...AP's strategy is to become a leading provider of deep, expert coverage on targeted business topics.

As for the AP, just in case you didn't know its background:

Founded in 1846, AP today is the largest and most trusted source of independent news and information. On any given day, more than half the world's population sees news from AP.

AP operates as a not-for-profit cooperative with more than 4,000 employees working in more than 240 worldwide bureaus. AP is owned by its 1,500 U.S. daily newspaper members. They elect a board of directors that directs the cooperative...

AP has received 49 Pulitzer Prizes, more than any other news organization in the categories for which it can compete. It has 30 photo Pulitzers, the most of any news organization.

Despite Fed rate cut, expect fixed-rate mortgage rates to rise

Today's rate cut by the Federal Reserve is certainly good news for borrowers with adjustable rate loans tied to the prime rate (such as many home equity loans), but it won't impact fixed-rate mortgage rates because their rates and risk models are figured differently; in fact, they could go higher if the Fed can't convince lenders to release some of the money they're hoarding. From a CNNMoney.com story:

The Fed's main tool is control over the short-term fed funds rate, which determines what banks charge each other for overnight loans. Long-term mortgage rates are mostly tied to the 10-year Treasury yield, which is determined by bond traders worldwide...

When the Fed cuts short-term rates, the intent is to lower borrowing costs for corporations so that they'll invest and hire. But this economic growth can lead to inflation.

That in turn leads bond traders to demand higher rates on their long-term bonds - and that drives up mortgage rates too...

There is more of a connection between Fed rate cuts and short-term and adjustable rate mortgages (ARMs). In fact, homeowners with ARM loans could see lower rates from further interest rate cuts.

Adjustable rate mortgages are pegged to a number of different indexes, including the one-year Treasury yield and the international Libor, or London Interbank Offered Rate, which tend to move with the Fed funds rate.

With Tuesday's rate cut, the cumulative effect of the Fed cuts could entirely offset what would have been a significant rate reset for many homeowners...

Sending long-term fixed rates back down will be more complicated than fixing inflation, because the continuing housing crisis is also exacerbating the rise in long-term fixed rates.

Generally mortgage rates are about 2 percentage points higher than the yield on the 10-year Treasury, which currently stands at 3.29%.

But the housing market is in such turmoil that rates are even higher right now, with lenders concerned that borrowers will not be able to pay back loans...

So for long-term fixed mortgage rates to go down, the Fed must successfully make banks more willing to lend again.

Thoughts on the Bear Stearns bailout

Following a lawsuit filed by the National Community Reinvestment Coalition against the Federal Reserve-backed purchase of Bear Stearns by JP Morgan for $2 per share, there have definitely been opposing opinions about this deal. From a USA Today report:

As the government-backed sale of Bear Stearns (BSC) shows, one man's bailout is another man's prudent government action to forestall a financial crisis.

Some have criticized the Federal Reserve for providing $30 billion in financing to facilitate the investment bank's forced sale to JPMorgan Chase (JPM). "I do see it as a bailout. … We may be left holding the bill as taxpayers," says John Taylor, CEO of the National Community Reinvestment Coalition...

The Fed's role in the Bear Stearns sale could end up costing taxpayers — or the government could make money on the deal. In return for $30 billion in financing, Bear provided as collateral difficult-to-price securities that investors now shun. If investor demand recovers, the Fed could turn a profit.

Others say the Fed's action was required to avert an even worse outcome. "You can say you don't want to reward risky behavior but … the sooner that we can clear the decks of the bad events, the sooner we can move forward," says economic consultant Carl Tannenbaum. "Otherwise, the risk is you could continue to see the dominoes falling, one institution after another."

This week's burst of federal action is the latest in a long line of crisis-fighting initiatives. In 1933, Franklin D. Roosevelt established the Home Owners Loan Corp. to help homeowners in danger of foreclosure. In 1984, the Fed provided billions of dollars to halt a global run on the nation's sixth-largest bank, Continental Illinois. Fourteen years later, Fed officials gathered top investment bankers in a New York conference room to prevent the failure of hedge fund Long-Term Capital Management from becoming a global financial crisis.

Yet, some Fed watchers are worried that its willingness to provide financing for investment banks has crossed the line into throwing good money after bad. "A bailout's already occurring under our noses, that we're not even aware of," says Joseph Mason, finance professor at Drexel University.

Latest edition of Builder Bytes out

The March 17th (St. Patrick's Day) edition of BuilderBytes is out. Summarizing top stories about economics and housing for the previous two weeks, it is emailed regularly to nearly 100,000 subscribers and also includes listings for upcoming conferences & seminars.