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Archive for June, 2007

[List-o-links] 6-29-07 Subprime Cuts: iPhones Used To Get Past Subprime Disconnect

June 29, 2007 | 12:32 pm | fedny |

Ok, not really but its a great way to present both subjects, which dominate the news right now. I was inspired by a colleague of mine who favors graph paper style shirts, and who suggested I address how the subprime mortgage implosion can be resolved through use of iPhones.

But try not to read between the lines.

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OFHEO/Case-Shiller In Hodgepodge Smackdown

June 27, 2007 | 8:41 am | nytlogo |

S&P released their Case-Shiller April 2007 index today A Hodgepodge of Declining Growth Returns in Home Prices According to the S&P/Case-Shiller® Home Price Indices [pdf] showing further housing market weakness.

A review of the decline in home price returns on a regional level shows no region is immune to the weakening price returns,” says Robert J. Shiller, Chief Economist at MacroMarkets LLC.

[question: is “hodgepodge” a macro econ term? I’ll check with Yoram Bauman.]

The index showed the fourth straight drop and the biggest decline since the index started in 2001. An index of 10 metropolitan areas fell by the most in at least 16 years. The Bloomberg article also has a heading that describes the index as most accurate. One gets the impression that a lot of effort is being spent by the S&P public relations machine to sell the credibility of the S&P/Case-Shiller index. News coverage tends to include something like what was presented in the Bloomberg piece:

The S&P/Case-Shiller index and another gauge by the Office of Federal Housing Enterprise Oversight track individual homes through repeat sales and more accurately reflect price trends, economists say. The measures from Commerce and the Realtors group can be influenced by changes in the types of homes sold. Higher sales of cheaper homes relative to more-expensive properties will bias the figures down.

OFHEO may feel threatened by the S&P/Case Shiller Index full court press and felt the need to substantiate their validity through a [pause while holding breath and say slowly] white paper called “A Note on the Differences between the OFHEO and S&P/Case-Shiller House Price Indexes [pdf]” written by Andrew Leventis dated June 22, 2007.

(Hap tip to a colleague who has lost more Blackberries than anyone on the planet.)

The fact that a government agency would go on the offensive to dress down a private sector competitor is unprecedented. Since the S&P/Case Shiller Index hasn’t done anything wrong, I can’t come up with a reason for this strategy.

Of course OFHEO is likely feeling the heat on several fronts, ranging from suggestions that they be replaced by another agency, their lack of oversight during the Fannie Mae accounting scandal and large bonuses just announced to their executives. They have been releasing other research works lately as well.

OFHEO basically says they are better than Case-Shiller because:

  • Case-Shiller excludes 13 states, including three of the fastest appreciating: Idaho, Montana and Wyoming data
  • Case-Shiller has incomplete coverage in 29 states and doesn’t clarify what specific areas are omitted.
  • OFHEO has more complete data.
  • Case-Shiller does not fully disclose their methodology.

Case-Shiller is a monthly index and OFHEO is a quarterly index, plus OFHEO only includes transactions with mortgages less than $417,000 (include values of refinance mortgages) and excludes a large swath of metro area prices.

Case-Shiller and OFHEO Indexes are similar because:

  • They are both repeat sales indexes.
  • They exclude new development, co-ops, condos and multi-families (CSI excludes foreclosures and flips)

Its a battle between government (OFHEO) and academia (Case-Shiller). I am hoping for a response from Case-Shiller although I doubt there will be one.

The benefit to the real estate consumer in all this whining and grandstanding exercise is more awareness of what these indexes actually offer and possibly allow for more transparency in the future. In other words, a hodgepodge of possibilities.


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[Curbed] Three Cents Worth: A Nice Luxury Spread

June 26, 2007 | 7:51 pm | curbed | Charts |

Its Tuesday, so its about time I place my Three Cents Worth post for Curbed online. With all the talk about the haves and the have-nots, this week I attempt to illustrate the increasing spread on a price per square foot basis.

To view post: A Nice Luxury Spread

Previous posts can be found here.


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Inflating The Subprimal Roof Of The Housing Market

June 25, 2007 | 11:59 am | nytlogo |

We’ve had some amazingly good weather in the Northeast for the past several days contrasting the national US housing market.

One the things I keep asking myself is: Why does conventional wisdom keep painting a rosy picture of the US economy, including worries about inflation, while housing is weak and getting weaker.

Here are today’s NAR stats (sorry to non-WSJ subscribers, but a bunch of links there today):

Existing-home sales dipped during May to their lowest level in nearly four years, while inventories climbed and prices fell a 10th straight time.

Home resales fell to a 5.99 million annual rate, a 0.3% decrease from April’s revised 6.01 million annual pace, the National Association of Realtors said Monday. April’s rate was originally estimated at 5.99 million.

The median home price was $223,700 in May, down 2.1% from $228,500 in May 2006. The median price in April this year was $219,800. The 2.1% drop marked the 10th consecutive year-over-year price decline.

Many foreign economies are getting overheated and their central banks are taking action to cool things off. One of the reasons the stock market has done well, despite housing’s weaknesses, has been the weak dollar and the resulting boost in corporate profits.

What does this all mean for stocks? Corporate profits have benefited from strength overseas and the weak dollar — one reason why stocks have been able to fly through the housing turbulence largely unscathed. The Dow industrials are up 7.2% so far this year, despite Friday’s selloff.

I have always pictured the Federal Reserve as having a laser-like focus on inflation, perhaps even with blinders on. That’s what they talk about, fret about, worry about and act upon. Consumers interpret them as being the captain of the ship, steering asset classes around trouble. However, the Fed seems less connected to asset class surges like stocks and housing of recent years and their causes. Limited oversight in lending activity, not just subprime is cause for concern. Consumers have been doing a lot of head scratching lately as to what the Fed is trying to achieve.

The US housing market has moved into slow burn mode, with declining sales activity, rising inventory and slipping prices. But more significantly, and perhaps most unexpectedly, the implosion of subprime and re-consideration of the entire mortgage process is getting worse.

As it turns out, all the hype about housing price bubbles has proved to be focused on the wrong thing. Rising housing prices in recent years are really more closely associated with easy credit. Easy mortgages (cheap and limited oversight) created the demand, which led to rising prices.

In past boom cycles like we saw in stocks and housing, (real) regulatory oversight proved difficult because the pace was so fast. Hence, the mortgage industry became the wild west.

Now we have Wall Street licking its subprimal wounds and they are expect to get bigger. Recent troubles with hedge funds and subprime make the point. There was little understanding of risk (does this sound familiar?). Subprime mortgages as a key issue doesn’t seem to be going away and I suspect we are at the tip of the iceberg, with a lot more mortgage problems to be revealed in the near future.

Yet curiously, conventional wisdom is shouting an improving economy and a threat of inflation as evidenced by the rising 10-year treasuries. Foreigners wonder when the US is going to enter a recession while Americans worry that the economy is getting over heated. Strange.

Gasoline prices have been falling (didn’t the same thing happen last summer?), and every day reveals more problems with subprime lenders and how the Wall Street didn’t appreciate risks associated with them because — guess what — by not understanding the asset values (or taking them seriously), they didn’t understand (I repeat) the risks associated with them.

I suspect the subprime problem will continue to expand, further weakening the stock market. Rising mortgage rates will further weaken national housing market, and we will still be scratching our heads when the possibility of recession becomes even more real.

Of course, I can’t tell if the head scratching is attributable too much sun and not enough reality.

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Brokers Sticking To Talkin’ About The Weather

June 25, 2007 | 12:01 am | nytlogo |

Source: NYT

In Vivian Toy’s excellent article Questions Your Broker Can’t Answer complete with cartoons and charts (I was in heaven), tackled the tough issue of fair housing laws and what brokers can say. There is a lot of bias out there generated from buyers and sellers, and real estate brokers can’t be party to it.

The problem is, that violations are often not seen by the violators since its been part of the dialog for so long. Just think of the lack of transparancy in co-op transactions. Whats so common in New York, like excluding lawyers by some co-op boards, is mortifying to most in other markets, no matter what your feelings about attorneys happen to be.

Ignorance may be bliss, but it won’t serve as an excuse any more.



[Getting Graphic] Building Until They Can’t Build Anymore

June 25, 2007 | 12:01 am | nytlogo |

Getting Graphic is a semi-sort-of-irregular collection of our favorite BIG real estate-related chart(s).

Source: NYT

Click here for full sized graphic.

In Floyd Norris’ column this weekend titled Homes Sell. Homes Don’t Sell. Builders Still Build. he notes that there is a disconnect between the demand for new homes and the number being built.

starts have been very high relative to the number of homes that builders are trying to sell, a fact that could indicate the weakness will last while builders seek to sell homes they have already built.

One of the things I have observed about builders is their powerful optomism. They have to be brash and fearless to be able to make things happen. That is part of their success formula. However, sometimes that can prevent them from seeing a downward change in demand. In addition, builders have their own internal infrastructure like staff, office space and aquired land.

New supply can often be like a conveyorbelt. It enters the market at a steady pace no matter what the current demand actually is.

They don’t always have the luxury of quickly adapting to a changing market or perhaps, their overhead prevents them from seeing the change until its too late after having gone 1 to 2 new developments too far.

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[Straight From MacCrate] Wall Street Has Not Learn The Lessons That Created FIRREA And The Debacle of the Seventies In Real Estate Lending and Investing!

June 24, 2007 | 1:54 pm |

Jim MacCrate, MAI, CRE, ASA, has worn many hats in his career. He taught a number of the appraisal classes I have taken through the Appraisal Institute and I think he is one of the few people who actually understands the “J-Factor.” His wife Judy is an SRA and is an accomplished appraiser in her own right, having managed an appraisal panel for a large lending institution throughout its various mergers for a number of years. I can only imagine the riveting conversations at dinnertime. Jim scratches his head as to why Wall Street and accounting firms often don’t see it coming in regard to real estate problems.

It is amazing that the Wall Street firms, such as Bear Stearns and Goldman Sachs, are having problems with their real estate loan portfolios and may be creating a time bomb that may create major problems in the economy. They appear to be repeating the same problems that the banking industry had in the late 1980′s and early 1990′s. I guess the accounting industry has also forgotten what happened because they should have an experienced professional real estate staff assisting the auditors in reviewing the loan packages, real estate appraisals and the like. Clearly, the auditors, such as PricewaterhouseCoopers, Deloitte & Touche, and KPMG, should be right on top of this situation with experienced real estate professional appraisers on their staffs. Investors may suffer losses because these firms may not have instituted proper safeguards, similar to FIRREA and other banking regulations to protect the investors from any losses.

Similar problems will probably occur in the commercial real estate market shortly (in a year or so). The rating agencies, such as Moody’s and Standard and Poor’s, should be right on top of this situation, along with the designated real estate appraisal professionals working at the major accounting firms.

The Federal Institutions Reform, Recovery and Enforcement Act of 1989(FIRREA) was passed to provide standards for real estate-related lending and associated activities by national banks to minimize losses from unsafe and unscrupulous lending practices. Maybe a similar law is required to regulate the Wall Street firms to protect investors from potential losses. Wall Street has an obligation to protect investors from losses due to the complex nature of many investment products and the underlying assets. The SEC and other investors, such as the state retirement systems that invest heavily in real estate, should review their current oversight procedures to insure that safeguards are in place to prevent a repeat of the debacle that occurred approximately seventeen years ago.

FIRREA is suppose to provide protection for federal financial and public policy interests in real estate-related transactions by requiring real estate appraisals performed by a State certified or licensed appraiser for all real estate-related financial transactions with few exceptions. (In fact, shouldn’t all real property appraisals for any purpose be performed by a State certified or licensed appraiser such as divorce, estate tax purposes and the like? That is not mandatory in every state, but it should be to protect the general public).

FIRREA further stated that the appraisal reports conform to generally accepted appraisal standards as evidenced by the Uniform Standards of Professional Appraisal Practice (USPAP) as promulgated by the Appraisal Standards Board of the Appraisal Foundation. Some these standards have been modified in the last several years increasing the risks to investors. The reports must written and contain sufficient information and analysis to support the institution’s decision to engage in the transaction. Appropriate deductions and discounts for proposed construction or renovation, partially leased buildings, non-market lease terms, and tract developments with unsold units must be analyzed and reported.

FIRREA further stated “if an appraisal is prepared by a staff appraiser, that appraiser must be independent of the lending, investment, and collection functions and not involved, except as an appraiser, in the federally related transaction, and have no direct or indirect interest, financial or otherwise, in the property. If the only qualified persons available to perform an appraisal are involved in the lending, investment, or collection functions of the regulated institution, the regulated institution shall take appropriate steps to ensure that the appraisers exercise independent judgment. Such steps include, but are not limited to, prohibiting an individual from performing an appraisal in connection with federally related transactions in which the appraiser is otherwise involved and prohibiting directors and officers from participating in any vote or approval involving assets on which they performed an appraisal.” Wall Street firms should have a similar procedure to insure that the real estate professionals are independent and not pressured to provide unrealistic indications of value just to make a loan package look good for resale to investors.

FIRREA specifically states that real estate loans should reflect “all relevant credit factors, including:

  • The capacity of the borrower, or income from the underlying property, to adequately service the debt.
  • The value of the mortgaged property.
  • The overall creditworthiness of the borrower.
  • The level of equity invested in the property.
  • Any secondary sources of repayment.
  • Any additional collateral or credit enhancements (such as guarantees, mortgage insurance or takeout commitments).”

Real estate markets should be monitored based on a thorough analysis of the real estate cycle, such as Glenn Mueller’s analysis from Dividend Capital so that investors can react quickly to changes in market conditions that are relevant to making investment decisions. Reappraisals may be required. Many factors that should be monitored and considered at a minimum include:

  • Deteriorating economic conditions.
  • Changes in the borrower’s financial capacity.
  • Major change in project design or configuration.
  • Construction delays resulting from cost overruns which may require renegotiation of loan terms.
  • Project target market change.
  • Demographic indicators, including population and employment trends.
  • Zoning requirements.
  • Current and projected vacancy, construction, and absorption rates.
  • Current and projected lease terms, rental rates, and sales prices, including concessions are changing.
  • Rent concessions or more discounts resulting in cash flow below the level projected in the original appraisal.
  • Current and projected operating expenses for different types of projects.
  • Economic indicators, including trends and diversification of the lending area.
  • Valuation trends, including discount and direct capitalization rates.
  • Slow leasing or lack of sustained sales activity.
  • Discovery or change in the environmental integrity of the site and surroundings.
  • The exclusion of excess land.
  • Loan renewals or extension requested.

The loan portfolios require testing to insure that the original appraisals have been prepared correctly and if it is determined to be inadequate or otherwise unacceptable, a new appraisal should be ordered. The real property interests should be reappraised annually until the risk rating improves for that particular loan. Random sample reappraisals should be conducted periodically to identify patterns of over or undervaluation by appraisers and/or firms, property type, location or market segment. These reappraisals should not be performed by the original appraiser.

These firms could improve on FIRREA by requiring a range in value reflecting the best case, most likely case and the worst case performance scenarios. Real estate appraisal is not science, but it is an unbiased, objective opinion of value based on logical reasoning supported by market information. Generally, a range in value is more meaningful because it shows the extremes that might occur and can be developed through a sensitivity analysis of the projected cash flows and valuation conclusions, possibly utilizing Crystal Ball Software. In the current environment a number of forces impact the process of determining the value of real property interests and marking assets and liabilities to market. Maybe Wall Street and their advisors should consider implementing the guidance provided by FIRREA and the banking regulators to reduce the risk exposure for investors.


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[on Matrix] Appraisal Pressure: Declaring The Obvious, Is A First Step

June 20, 2007 | 3:21 pm |

Here is an appraisal-related post on our other blog Matrix: Appraisal Pressure: Declaring The Obvious, Is A First Step that discusses the New York Attorney General’s request of appraisers to make a declaration that appraisal pressure is a problem.


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Appraisal Pressure: Declaring The Obvious, Is A First Step

June 20, 2007 | 3:11 pm | bloomberg_news_logo |

The New York State Attorney General’s Office reportedly asked many appraisers to submit a formal declaration if they have been pressured by the lending community to provide specific appraisal results, with the threat of withholding future business if the appraiser does not comply. As Sharon Crenson of Bloomberg News reports today, in the news story Cuomo Expands Probe as Appraisers Attest to Pressure:

New York Attorney General Andrew Cuomo is asking home appraisers to declare in writing that they were improperly pressured by mortgage brokers and lenders to inflate estimates…

Its a pretty basic statement since thats the state of the mortgage industry as it currently exists. I have written, spoke, blogged about appraisal pressure until I was blue in the face about the topic so it wasn’t hard to sign the AG’s declaration. In fact, it was a relief.

This has been an exciting time. Ok, maybe exciting is too strong, but its a top twenty right up there with birth of our 4 kids, my marriage to my wife, Yankees winning a World Series (lumping all 26 in one slot for space considerations) and getting a parking space in the commuter lot of my train station.

The AG is taking tangible actions. It seems to me that the first issue, in a strange way, is getting the victims (some appraisers) to actually state there is a problem. I suspect many appraisers are not committed to the idea of coming forward for fear of retribution from their existing clients.

One small step for man (appraiser), one giant step for the mortgage industry.



Broad Side The Barn, Waiting For The Shovel

June 19, 2007 | 12:05 pm | fedny |

As a kid, I remember the popular dress-down phrase: “You couldn’t hit the broad side of a barn.” Fast forward to today and the phrase becomes: “You don’t even know what your mortgage amount and terms are.” (note: this is a clue to how boring I was as a kid, especially on the baseball field.)

One of the things that occurred in the housing boom of the past decade was the detachment of risk from the borrowing equation. It didn’t matter how you got there, you simply wanted the property or the loan.

The LA Times reports (via Seeking Alpha) that a Federal Trade Commission study shows that despite (or because of) a myriad of closing documents, borrowers only had a 50/50 chance of finding the loan amount on their loan documents.

View the study.

Peter Coy of Businessweek concurs and lays blame on lenders, not borrowers in his Hot Properties post:

  • Half the 819 borrowers surveyed could not correctly identify their loan amount.
  • Two-thirds did not recognize that they faced a two-year prepayment penalty.
  • Three-quarters did not recognize that they were paying extra for optional credit insurance.
  • Nearly 90% couldn’t identify the total amount of upfront charges in the loan.

It’s easy to blame the borrowers…But when so many people can’t understand the loan documents, I put most of the blame on the lenders.

Ok, so now we have loan applicants not understanding what they are actually borrowing.

Now the Federal Reserve, who is responsible for overseeing the banking industry, has less influence on the economy, and perhaps by extension, less influence on credit quality.

But a new study by the Federal Reserve shows it has much less control over economic growth than assumed by many. The study, completed by Fed economists, found little evidence that tighter monetary policy has much impact on bank lending via deposits.

Greg Ip, the WSJ reporter who covers the Fed, writes about this in the WSJ Real Time Economics Blog:

banks with more deposits than loans, and banks with far less deposits than loans (because they relied more on wholesale markets), didn’t change lending much when deposits shrank. Only banks whose deposits were about equal to loans significantly reduced lending. These banks only represent 6% of of U.S. bank assets. Thus, the “bank lending channel seems limited in scope and importance” in the U.S., the authors conclude.

6% is pretty low.

But lending standards are getting tighter. Where is this coming from?

The Federal Reserve seemed to back away from the potential subprime problem back when Greenspan was there. This laissez-fare policy would likely have applied to all types of bank lending.

So bank underwriting is getting tougher on its own initiative, probably only after seeing the damage occurring to the housing market as of late.

Lets summarize:

  • Borrowers don’t know how much they borrow.
  • Bank regulators say themselves, that they have no significant influence on the economy and, it follows by past action, no significant desire to reign in the banks they regulate (admittedly a stretch, but let me have it).
  • Banks have now become tougher on borrowers which will further damage the collateral on their outstanding home loans as restrictions to credit will constrain demand.

Everyone seems to be counting on someone else to take care of things – thats a disfunctional financial community.

As former presidential candidate Ross Perot once uttered: “Its time to pick up the shovel and clean out the barn.”


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