Stocks - Bear Market

Be very careful about this bear market in stocks.

It reminds me very much of the early '70's bear market, where analysts kept touting value all the way to the bottom.



Take a look at the 20 year chart of the Nasdaq below:





















Here's what worries me about this long term chart:

1) the momentum index in not even close to be oversold, in fact, it's just now rolling back over from the oversold rally we had from March 17 2008 to the May 19/June 5 double top.

2) A break below the long term trendline (the trendline that begins all the way back in January of 1991) at roughly 2000 would suggest a return to the lows of 2002 in the Nasdaq.

Shorter term, the Nasdaq is sitting right on a critical short term trendline at approximately 2294.

The disconcerting part, to me, is that the potentially negative technical picture fits in extremely well with the de-leveraging scenario which is playing out in the credit markets. It does not paint a pretty picture.

It appears that we're in the middle of a rather long process of de-leveraging debt in the credit markets. And the economy is not going to begin to recover until the credit market issues are resolved. So don't expect the stock market to head higher in any meaningful way until there is some clarity regarding solutions to the problems in the credit markets.

When you try to pinpoint when this all started, you can point to a number of timeposts:

1) November of 2006...this is when, in my opinion, New Century knew, for real, how bad things were within their portfolio. They didn't forward the information until December, but the Captains at New Century had to know in November.

2) March/April 2007...in four short months virtually every subprime lender in the country went bankrupt.

3) May 2007...this is when Fannie Mae's Desktop Underwriter began to tighten. For conforming loans, this is the beginning of the de-leveraging.

4) June 2007...we began to see a number of loan programs taken off the market. Programs such as no-ratio, no-doc went bye-bye.

5) July 2007...Prominent 2nd mortgage lenders began to discontinue their 2nd mortgage programs.

6) August 2007...Construction lending programs began to bite the dust at various lenders. Jumbo loans became virtually non-existant,and when you could get a Jumbo loan, very expensive. The Fed makes an inexplicibly stupid decision not to cut rates. I mean this was downright dumb as a stump type of decision. I still can't figure this one out. It is clear that our Federal Reserve was absolutely clueless about the problems in the credit markets in August '07, 100% head in the sand clueless. This Fed meeting should go down in infamy.

7) September '07 through January '08...the above trends continued unabated. Finally, with a series of rate cuts, and an extremely rare inter-meeting rate cut, the Fed signals that they FINALLY understand the severity of the problem in the credit market.

8) February '08...President Bush signs the fiscal stimulus package that along with sending out checks to everyone, also temporarily increases the conforming loan limits, as well as temporarily increasing FHA loan limits.

9) March 17 '08...JP Morgan/Fed intervene to engineer a JP Morgan buyout of Bear Stearns. This buyout essentially averted what would've been, most probably, at least a short term halt in our credit markets.

As you can see from the timeline above, while our credit crisis began 19 months ago, we've only really begun to address the problem within the last 6 months.

Other shoes that may drop in the coming weeks/months:

Mortgage insurers begin to fail. Remeber, the mortgage insurers are also in other insurance businesses. They've taken a number of very hard body blows through this mortgage debacle, and even though they're still standing, it won't take much more to knock them out.

Could Bank of America back away from the Countrywide deal? I think that's a decent possibility.

I could see at least a half dozen major wholesale mortgage lenders close their doors in the next six months. I'm not naming names at this point, but I've got several lenders on my major distress list.

Could we see 2nd mortgages disappear completely? It's possible, there are only a handful of wholesale mortgage lenders that haven't shut down their 2nd mtg programs.

OFHEO News

Interesting News Regarding OFHEO, from Seeking Alpha

http://seekingalpha.com/article/81135-ofheo-gse-s-loan-loss-capital-reserve-requirements-to-change-housing-tracker

OFHEO: GSE's Loan Loss/Capital Reserve Requirements To Change

Quote of the Day

“This is the investment of a lifetime.” - Jun Han, author of an extensive study of the CMBS market for the Commercial Mortgage Securities Association. Han attributed CMBS’ poor performance, among other things, to the unfortunate effect of having the word “mortgage” in its name—causing investors to automatically extend fears about the residential market’s troubles to the commercial market. (Commercial Property News, June 10th)

Subprime Fallout

A Cold Market For Jumbo Loans Shows Signs Of A Thaw; Borrowers Seeking Up To $729,750 See Rates Ease. “Rates on conforming jumbos began declining in May after Fannie said it would buy the loans for its own portfolio -- instead of trying to sell them to investors. It also said it would buy them at interest rates that were on par with smaller conforming loans... Rates on 30-year fixed-rate conforming jumbos averaged 6.39% last week, just 0.14% above the 6.25% for conforming loans of less than $417,000... Also, Fannie and Freddie have loosened their underwriting criteria a bit… The February stimulus package also raised the Federal Housing Administration's maximum loan amount to $729,750.” (LA Times, June 12th)

Lewis Remains Committed To Buying Countrywide. “Bank of America Corp. (BAC) CEO Ken Lewis said Wednesday that there are no plans to call off its $4 billion deal to acquire Countrywide Financial Corp. and that he believes charge-offs and delinquencies in the U.S. will peak in Q3. Lewis also affirmed his commitment to his company's investment banking unit and said this quarter may be among its most profitable. In the home loan market, Lewis pointed out that the Charlotte bank will control a 20 percent to 25 percent market share once the Countrywide deal is completed, and that will boost business once the housing crisis comes to an end.” (Charlotte Observer, June 12th)

Financials Resist Plan On Rating Reforms. “Proposals being considered by US regulators to force credit ratings agencies to brand structured products with special symbols are facing opposition from financial industry participants. The idea of differentiating the ratings of complex debt and mortgage-related products - which are at the heart of the credit crisis - from other traditional debt is likely to be addressed as part of a new rules for rating agencies to be proposed today by the US SEC. Ratings agencies, which are paid by the issuers whose securities they rate, have been criticized for failing to act quickly enough to warn investors about complex debt products.” (Financial Times, June 11th)

Higher Week-To-Week Mortgage Applications: MBA. “Mortgage Bankers Association: Mortgage applications filed in the week ended June 6 rose 10.9% on a seasonally adjusted basis compared to the [previous] week. The increased filings for both mortgages to buy homes and re-financings of existing mortgages coincided with higher interest rates on fixed- and adjustable-rate mortgages… Total application volumes were down an unadjusted 16.5% compared with the same week in 2007. Refinancing applications increased 8.4% week-to-week. Filings for mortgages to purchase homes rose a seasonally adjusted 12.8%... Refinance applications made up 39.8% of all MBA mortgage activity… ARMs accounted for 10.3% of all applications, up from 8.7%.” (MarketWatch, June 11th)

Is BofA-Countrywide Deal Bad News for FIS? “Fidelity National Information Services (FIS), Inc. could be facing a loss in business when Bank of America (BAC) and Countrywide Financial Corp. (CFC) complete their merger later this year. SEC filing: FIS said its subsidiary Lender Processing Services Inc. stands to lose business with BofA announcing the possibility that it will consider no longer using the mortgage processing and appraisal services now provided by LPS after its merger with Countrywide. FIS says BofA is leaning towards handling those particular functions in-house. FIS added, “These services together generated approximately 1.4% of FIS consolidated and 4% of LPS revenue in 2007.” (Default Servicing News, June 11th)

OFHEO’s Updated Rule Could Change GSEs’ Loss Severity Calculations. “New Office of Federal Housing Enterprise and Oversight proposed guidelines… will change the core risk-based capital requirements that Fannie Mae and Freddie Mac are required to carry to ensure the platforms are protected when credit-risk conditions or interest rates worsen… “Unaltered, the loss severity equations overestimate Enterprise recoveries for defaulted government-guaranteed and low loan-to-value mortgages. Those results are not consistent with the Risk-Based Capital regulation and result in significant reductions to the risk-based capital requirements of the Enterprises.” The second change will correct the GSEs’ “prior treatment of FHA insurance associated with single-family mortgages with an LTV below 78%,” which is currently non-compliant with current laws.” (Default Servicing News, June 11th)

Mortgage-Related Credit 'Stable' At Big Banks. “The overall mortgage-servicing portfolio of the nation's nine largest firms in the industry shows credit quality that is "relatively satisfactory and relatively stable" over the last two quarters, the federal Office of the Comptroller of the Currency said Wednesday.” (MarketWatch, June 11th)

MBIA Letter to Shareholders. “MBIA announced it won't make a planned $900 million capital contribution to MBIA Insurance Corporation. I also found [MBIA’s press release] interesting: “[B]ased on our discussions with the rating agencies and in trying to think about their challenges, what I believe has really changed in the past three months is that both Moody’s and S&P have far less comfort in forecasting a worst case housing-related stress case loss scenario.” CR: I'm not surprised that Moody's and S&P feel less comfortable forecasting a worst case for housing - every time they've made a forecast, the housing market has surprised to the downside.” (Calculated Risk, June 11th)

Mortgages No Longer a Stigma in Retirement; Many Will Never Pay Off Home Loans. “Third annual Affluent-Boomers-at-60 survey from Bell Investment Advisors: [While] the prior generation’s [retirement goal] was to “burn the mortgage,” more than 55% of boomers surveyed who currently hold mortgages do not plan to pay their mortgages off until their 70s, if ever. This trend was most pronounced in the Western US, where 31% of those with mortgages do not ever intend to pay them off, compared with 25% in the South, 18% in the Midwest and 11% in the Northeast. Of the 500 boomers surveyed approximately two-thirds currently have mortgages on their residences. The remaining third either rent or do not have a mortgage.” (Originator Times, June 11th)

Growing Lender Announces Plan to Hire 75-100 Mortgage Professionals. “Residential Finance Corporation (RFC), a nationwide mortgage lender, announced its continued expansion plans to hire between 75-100 people in Q3’08. The majority of job openings will fill mortgage banking positions in the company's Columbus, OH headquarters and Tampa, FL location. RFC President, Michael Isaacs: What sets us apart and helps drive our growth in today’s market is our continual investment in technology, training and marketing.” (Originator Times, June 11th)

HUD Still Trying To End Seller-Funded Loans. “The Bush administration is again moving forward with a proposal to ban seller-funded down-payment assistance for FHA-backed loans, reopening the public comment period on the plan for 60 days. The Department of Housing and Urban Development was forced to reopen an administrative proceeding on the rule change after a judge ruled it did not adequately explain its reasons for reversing past policy on seller-funded loans -- a practice it defended as recently as 2005… Now HUD argues that the loans artificially inflate home prices and are three times more likely to end up in foreclosure.” (Inman News, June 10th)

More Stress is Forecast for Banks. “Bank lending to real estate developers [is] an emerging threat and more failures [are expected]… Donald Kohn, vice chairman of the Federal Reserve: "We expect bank holding companies to continue to report weak earnings and further asset valuation write-downs and/or significant credit costs in coming quarters… Coverage of nonperforming loans by loan loss reserves has not kept pace with growth in problem assets and bank holding companies may likely… need to further bolster loan loss reserves." Sheila Bair, chairman of the Federal Deposit Insurance Corporation: "Banks continue to experience increased [earnings] pressure resulting from a deterioration in credit quality… particularly pronounced in construction and development lending." (Int’l Herald Tribune, June 10th)

Great Read For First Time Homebuyers

As you can imagine, I work with and talk to a number of first time homebuyers. A large percentage of our work is devoted to helping first time homebuyers purchase their first home. One of the things I've noticed in life is that once someone owns a home, their thought process changes. The difference in thinking like a renter versus thinking like an owner is a transformation from thinking in terms of spending to one of building wealth. It's an amazingly satisfying process to be a part of, even in the midst of the difficult real estate market we're experiencing today.

Well, with that as a backdrop, I found an article today by David Brooks, of the NY Times, to be extremely interesting. Entitled: "The Great Seduction" the article is about a study conducted primarily by the Institute for American Values and is titled: “For a New Thrift: Confronting the Debt Culture”.

http://www.nytimes.com/2008/06/10/opinion/10brooks.html?_r=2&ref=opinion&oref=slogin&oref=slogin

The United States has been an affluent nation since its founding. But the country was, by and large, not corrupted by wealth. For centuries, it remained industrious, ambitious and frugal.
Over the past 30 years, much of that has been shredded. The social norms and institutions that encouraged frugality and spending what you earn have been undermined. The institutions that encourage debt and living for the moment have been strengthened. The country’s moral guardians are forever looking for decadence out of Hollywood and reality TV. But the most rampant decadence today is financial decadence, the trampling of decent norms about how to use and harness money.

Sixty-two scholars have signed on to a report by the Institute for American Values and other think tanks called, “For a New Thrift: Confronting the Debt Culture,” examining the results of all this. This may be damning with faint praise, but it’s one of the most important think-tank reports you’ll read this year.
The deterioration of financial mores has meant two things. First, it’s meant an explosion of debt that inhibits social mobility and ruins lives. Between 1989 and 2001, credit-card debt nearly tripled, soaring from $238 billion to $692 billion. By last year, it was up to $937 billion, the report said.

Second, the transformation has led to a stark financial polarization. On the one hand, there is what the report calls the investor class. It has tax-deferred savings plans, as well as an army of financial advisers. On the other hand, there is the lottery class, people with little access to 401(k)’s or financial planning but plenty of access to payday lenders, credit cards and lottery agents.

The loosening of financial inhibition has meant more options for the well-educated but more temptation and chaos for the most vulnerable. Social norms, the invisible threads that guide behavior, have deteriorated. Over the past years, Americans have been more socially conscious about protecting the environment and inhaling tobacco. They have become less socially conscious about money and debt.

The agents of destruction are many. State governments have played a role. They aggressively hawk their lottery products, which some people call a tax on stupidity. Twenty percent of Americans are frequent players, spending about $60 billion a year. The spending is starkly regressive. A household with income under $13,000 spends, on average, $645 a year on lottery tickets, about 9 percent of all income. Aside from the financial toll, the moral toll is comprehensive. Here is the government, the guardian of order, telling people that they don’t have to work to build for the future. They can strike it rich for nothing.

Payday lenders have also played a role. They seductively offer fast cash — at absurd interest rates — to 15 million people every month.

Credit card companies have played a role. Instead of targeting the financially astute, who pay off their debts, they’ve found that they can make money off the young and vulnerable. Fifty-six percent of students in their final year of college carry four or more credit cards.

Congress and the White House have played a role. The nation’s leaders have always had an incentive to shove costs for current promises onto the backs of future generations. It’s only now become respectable to do so.
Wall Street has played a role. Bill Gates built a socially useful product to make his fortune. But what message do the compensation packages that hedge fund managers get send across the country?

The list could go on. But the report, which is nicely summarized by Barbara Dafoe Whitehead in The American Interest (available free online), also has some recommendations.

First, raise public consciousness about debt the way the anti-smoking activists did with their campaign.

Second, create institutions that encourage thrift.

Foundations and churches could issue short-term loans to cut into the payday lenders’ business. Public and private programs could give the poor and middle class access to financial planners. Usury laws could be enforced and strengthened. Colleges could reduce credit card advertising on campus. KidSave accounts would encourage savings from a young age. The tax code should tax consumption, not income, and in the meantime, it should do more to encourage savings up and down the income ladder.

There are dozens of things that could be done. But the most important is to shift values. Franklin made it prestigious to embrace certain bourgeois virtues. Now it’s socially acceptable to undermine those virtues. It’s considered normal to play the debt game and imagine that decisions made today will have no consequences for the future.

Are We Beginning To See A Bottom In Housing

I'm not saying that the housing market is good. More like we've been in a 150 mph hurricane and the winds are subsiding to 75 mph. But there is a trickle of evidence that the collapse in the housing market is beginning to bottom.

On May 27, "Sales new single family homes recovered 3.3% to 526,000, but the March decline of 11.0% was revised deeper from an initial indication of an 8.5% drop. Sales were down 62.1% from their July 2005 peak. An April sales level of 527,000 had been expected." - Haver Analystic.

June 9: Foreclosures declined in May for the second straight month, indicating that the housing picture may be brightening, according to ForeclosureS.com, a Fair Oaks, Calif.-based investment advisory firm.

Foreclosures dropped 12.0% in May from the previous month's level, and the number of homeowners facing preforeclosure fell 8.9%, the company said. (National Mtg News). A forward-looking indicator of existing-home sales rose 6.3% in April, its highest level since October, according to the National Association of Realtors. The NAR's Pending Home Sales Index, which is based on sales contracts signed in April, rose to 88.2 in April from 83.0 in March. On a year-over-year basis, the index was down 13.1 %.

Slowly, we are digging out of this housing crisis. Make no mistake, it's going to be a long bottoming process, emphasis on process, but at least that stage of the process appears to have begun.

Case-Shiller v. OFHEO: A Tale Of Two Indices

We took a look at the recent release of the Case-Shiller Seattle index and the OFHEO index.

A quick explanation, the Case-Shiller index essentially measures all housing prices (subprime, conforming, and Jumbo) in 30 geographic markets in the U.S. Seattle is one of those markets. The OFHEO index (Office of Federal Housing Oversight), on the other hand, measures a wider geographic range, dividing the data between East North Central U.S., Middle Atlantic, etc, rather than specific cities, like Seattle. The other critical difference between the two indexes is that the OFHEO index measures only conforming loans from Fannie Mae and Freddie Mac.

The latter distinction is critical, because the segment of the real estate market that has been hardest hit is the part of the market that was articificially inflated with the use of the new derivative related loans: subprime, Alt-A, Jumbo.

The Case-Shiller index still looks grim for Seattle. One measure we look at is what we deem long term trend growth, with that growth rate for the Seattle market from February 1991 to March 2008 at 4.50%. See chart below.

The Case-Shiller index is currently 28.13% above the 4.5% trend.

The OFHEO index is in much better shape, currently 7.18% above trend. It appears that much, though not all, of the correction has taken place in the OFHEO Index in the last year, going from 28% over trend in April 2007 to 7% in March '08.

Conclusion: The conforming housing market ($417,000 or less) is much further along in the correction process than upper tier (reflected in the Case-Shiller index).

It's actually a very reasonable time to be a 1st time hombuyer, considering that 1st Time Homebuyers tend to need seller paid closing costs much more often, and sellers are more willing to pay selling concessions.