Deal With Devil' Funded Carrera Crash Before Bust (Update3)

By Bob Ivry

Dec. 18 (Bloomberg) -- One week in 2002, Daniel Sadek was $6,000 short of covering the payroll for his new subprime mortgage company, Quick Loan Funding Corp. So he flew to Las Vegas and put a $5,000 chip on the blackjack table.

``I could have borrowed the money, I suppose,'' Sadek says.

That wouldn't have been his style. With his shoulder-length hair and beard, torn jeans and T-shirts with slogans such as ``Where is God?'' Sadek looked more like a guitarist for Guns N' Roses than a mortgage banker.

Sadek says he was dealt a jack, then an ace. Blackjack. He would make payroll. Quick Loan Funding, based in Costa Mesa, California, would survive and, for a while, prosper as one of 1,300 mortgage lenders in the state vying to satisfy Wall Street's thirst for subprime debt.

As home prices rose and hunger for high-yield investments grew, Sadek found his niche pushing mortgages to borrowers with poor credit. Such subprime home loans grew to $600 billion, or 21 percent, of all U.S. mortgages last year from $160 billion, or 7 percent, in 2001, according to Inside Mortgage Finance, an industry newsletter. Banks drove that growth because they could bundle subprime loans into securities, parts of which paid interest as much as 3 percentage points higher than 10-year Treasury notes.

``I never made a loan that Wall Street wouldn't buy,'' Sadek says. He worked hard to build the business, he says, and the company did nothing illegal.

U.S. Pays the Bill

In 2005 and 2006, New York bankers expanded the market for mortgage-backed securities by creating new subprime derivatives contracts. The derivatives, which amplified the risks of the underlying mortgages, were sold to banks and institutional investors. When borrowers started to default on high-yield, high- risk subprime mortgages by the thousands, the values of these leveraged securities plunged.

An index of subprime loans made in the second half of 2005 fell to as low as 21.83 cents on the dollar from a high of 102.19 cents. It's now at about 30 cents.

Nearly one in six subprime borrowers has missed a monthly payment, sending home prices to their first annual decline since the Great Depression. The Federal Reserve cut its main interest rate three times to fend off recession, and Wall Street firms that posted record profits the last three years have written down more than a combined $80 billion on subprime-related losses.

Sadek, now 39, got into the lending business in 2002, just as home prices were in the early stages of a record five-year surge. Staked by banks including Citigroup Inc., Sadek and others in his industry tripled the subprime market in five years.

Lamborghini, McLaren, Soap Star

``I was working every day, all day, from dusk to dusk,'' says Sadek, who pumped gas and sold cars before creating Quick Loan Funding. ``I slept in my office sometimes. I worked about 80 or 90 hours a week.''

Sadek collected a fleet of cars that included a Lamborghini, a McLaren, a Ferrari Enzo, a Saleen S7 and a Porsche, frequented casinos and was engaged to soap opera actress Nadia Bjorlin.

``Daniel was charismatic, crazy, unconventional and passionate about his company and his borrowers,'' says Lisa Iannini, a former employee.

Sadek would try to help Bjorlin break out of TV's ``Days Of Our Lives,'' co-writing and spending $35 million to produce ``Redline,'' a feature film about illicit car racing, starring Bjorlin as a daring leadfoot.

The movie's climactic line, delivered by actor Angus Macfadyen: ``Do you believe in destiny?''

Sadek did.

Wiping the Slate Clean

When homeowner Christopher Aultman, a mechanic for Union Pacific Railroad, called Quick Loan Funding in July 2005, a man identifying himself as Tim answered.

``He was friendly and he sounded like he knew what he was talking about,'' Aultman says.

Aultman wanted to refinance the 30-year fixed-rate mortgage on his four-bedroom home in Victorville, California, 80 miles northeast of Los Angeles. He needed to tap $20,000 in equity to pay off mounting debts, and he wanted to build a backyard play area for his three children.

His average credit score was 465 out of a possible 850, according to Aultman's loan documents. That is well below the U.S. median of 720, according to Fair Isaac Corp., whose software measures consumer creditworthiness.

Quick Loan Funding was the only lender that would talk to him, Aultman says.

``We'd been struggling and running away from bills, and I was tired of living that way,'' says Aultman, now 35. ``I wanted to be responsible and take care of my debts and wipe the slate clean.''

Passed Officer to Officer

A year earlier, Aultman had paid $204,000 for the house. Quick Loan Funding's appraiser said it was worth $360,000. When Aultman called back later with questions, he says he was told Tim no longer worked there.

``I was passed from loan officer to loan officer,'' Aultman says. ``It just didn't feel right. But I was praying it was going to come through. I was desperate.''

Loan officers were hired and fired all the time at Quick Loan Funding's 26,000-square-foot call center in Irvine, says Bryan Buksoontorn, who joined the company in 2004. By then, Irvine had become a hotbed of subprime lending companies.

``We were motivated by fear,'' says Buksoontorn, 28, who is now an independent mortgage broker. ``It was a boiler room. You had to make your numbers.''

Buksoontorn's job: get the caller's credit card and charge $475 for an appraisal, he says.

``You told the callers what they wanted to hear and you got the credit card,'' says Steven Espinoza, 39, an employee from 2003 to 2005.

`Close 'Em, Close `Em'

Sadek and his managers would berate the sales staff, many of whom had no experience or training, Buksoontorn says.

``They would get in your face,'' he says. ```Why aren't you ordering appraisals? Why aren't you selling?' ''

Sadek brought a car salesman's mentality to mortgages, Espinoza says.

``It's the same type of hard sell,'' Espinoza says. ``Close 'em, close 'em, close 'em.''

Iannini, who was vice president for compliance and risk management, says she tried to make sure the hard sell didn't result in bad loans.

``I went to work every day as an uninvited hall monitor at a fraternity party,'' Iannini says.

Sadek says 95 percent of Quick Loan Funding's mortgages were made to subprime borrowers.

``If we had a prime borrower on the line, we hung up on them,'' Buksoontorn says. ``We were geared toward subprime because they were easier to close. We were giving them money no other bank would dare to give them.''

Citigroup's Backing

Sadek says that with the support of Citigroup, which funded the loans, he pioneered lending to homebuyers with credit scores of less than 450.

Citigroup spokesman Stephen Cohen said the bank doesn't comment on its relationships with clients.

``We made most of our money from selling loans to banks,'' Sadek says.

Quick Loan Funding, like many subprime companies, specialized in 2/28 loans -- 30-year mortgages that start with lower ``teaser'' interest rates and ratchet higher after two years.

A key selling point was the 50 percent rise in home prices nationally from 2001 to 2006, according to the National Association of Realtors. Mortgage salespeople told homeowners that as long as values continued to increase, they could refinance or sell before their interest rates jumped.

`They Believed'

It wasn't a lie. Year over year, prices hadn't fallen since the 1930s, according to the Realtors group. The belief that values would form a stairway even seduced Quick Loan Funding employees who took out 2/28 loans themselves, says Marcus Bednar, 32, a former sales manager.

``They believed everything the borrowers believed, that the market was going to go up,'' Bednar says. ``It wasn't just something we were pushing because we tried to rip people off.''

Bednar adds, ``We were never encouraged to do anything shady.''

Borrowers with subprime adjustable-rate mortgages are seven times more likely to default than those with prime fixed-rate mortgages, according to the Mortgage Bankers Association.

Quick Loan Funding, like most subprime lenders, wrote so- called stated-income or ``no doc'' loans that don't require the borrower to document income with pay stubs or tax forms. They are also known as ``liar loans.''

The Federal Reserve staff today recommended a ban on such loans.

Reviewed, Rejected

In 2004, Bohan Group, a due diligence underwriting company, was hired by a bank to double-check the suitability of mortgages written by Quick Loan Funding that the bank was looking at buying and turning into securities. Bohan sent Nicole Singleton, 39, to the Irvine office. She reviewed 40 loans and rejected every one, she says.

Sadek says he fostered a competitive selling atmosphere, and underperforming workers ``either quit because they're not making money or they're fired because they don't work.'' He says Quick Loan Funding ``thrived on customer service, so the idea of hanging up on callers is not right.''

``If the loans were so bad, why did Wall Street keep buying them?'' Sadek says.

In July 2005, Espinoza, Buksoontorn, Bednar and other employees sued Quick Loan Funding in federal court alleging various workplace abuses, including failing to pay overtime and not providing adequate lunch breaks. Sadek later settled with the employees, agreeing to pay them more than $3 million, says Jon Mower, an Irvine attorney who represented the loan officers.

``I don't think Quick Loan Funding was much different than many of the other subprime companies,'' Mower says.

`I Can't Do This'

Sadek denies the charges, adding that it's the type of lawsuit a jury would never decide in the employer's favor.

``They see me as a rich guy and who do you think they are going to believe?'' he says.

To get $20,000 in cash from the Quick Loan Funding refinance, Aultman was told, his monthly payments would rocket to $2,264 from $1,464.

``I said I can't do this,'' Aultman says. ``They said take the mortgage, make the payments and once everything is paid off, within 30 days your credit will shoot up 150 points and we'll get you a better rate and everybody wins.''

They convinced him, he says. The company sent a notary to his house with the documents to sign. It was 9:30 p.m. Aultman was worn out from work and the rest of the family was in bed.

Aultman says he didn't see the pre-payment penalty in his contract. If he refinanced within two years, he'd have to pay six months interest.

Crying in Son's Room

He also says he didn't notice his income on the contract: $5,950 a month. At the time Aultman says he made $3,420.

Sadek says he watched employees closely and anyone caught falsifying information would be ``fired on the spot.''

For a $247,500 mortgage, Aultman paid Quick Loan Funding $10,813, including origination fee, application fee, processing fee, underwriting fee and quality control fee, according to his loan documents.

The average closing costs for a mortgage of that amount in California is about $5,000, according to Pete Ogilvie, president of the California Association of Mortgage Brokers.

Sadek defends charging those fees by saying he took more of a risk by lending to people with such lousy credit. If legislators want to limit fees, they ought to pass laws against them, he says.

Aultman received $21,674.70 in cash, according to the documents.

The monthly payments proved too steep and he fell behind.

``I feel burned,'' Aultman says. ``There's a lot of nights I've gone into my son's room and watched him sleep and I've cried.''

Reining in Loan Officers

Quick Loan Funding's survival, like that of other non-bank mortgage lenders, depended on a stream of new borrowers like Aultman. To fund the mortgages, the company had $400 million in short-term credit from Citigroup. To pay that off, Quick Loan Funding sold the mortgages to securitizers as soon as it could.

By August 2005, Sadek was spending most of his time working on his movie, ``Redline.'' He hired Iannini to upgrade the company's risk management.

``My biggest problem day to day was reining in uneducated loan officers,'' Iannini says. ``You have to almost use police force tactics and threaten brutality on a sales floor of a lending institution and have that whip ready to crack, because you never know what employee will be pressured by what influences on any given day.''

Iannini had worked at two other mortgage lenders before joining Quick Loan Funding. She says Sadek's firm was the most committed of the three to maintaining lending standards.

Ferrari Crash

Asked about borrowers who have trouble making their payments, Sadek quickly leafs through a mortgage application. He stops, folds over the pages and points to the line that says, ``Cash to borrower.''

``Who's getting ripped off?'' he says.

Sadek was featured on TV newscasts in March. During a publicity event for ``Redline'' at an Irwindale racetrack, comedian Eddie Griffin, a star of the movie, drove Sadek's $1.2 million Ferrari Enzo into a concrete barrier, wrecking it.

Sadek, who appears in ``Redline'' as a poker player, also intentionally trashed two of his own Porsches in the making of the movie. In one scene, a Carrera is catapulted high in the air before it crashes.

Aultman, meanwhile, says his credit score hasn't climbed and he has received two notices of foreclosure since refinancing with Quick Loan Funding in November 2005.

`Everything's Not OK'

``You go to soccer games, and everything's great with the other parents,'' Aultman says. ``Nobody knows it, the wife doesn't know it, the kids don't know it, but their old man is in trouble. I put up a façade that everything's OK. Everything's not OK.''

Aultman is trying to sell his house, but three others within sight of his driveway also have for-sale signs.

``I'm embarrassed,'' Aultman says. ``I made a deal with the devil. I didn't know what I was signing.''

Sadek may be in trouble, too. The California Department of Corporations wants to revoke his lending license. The state says he tried to use the bank account of his escrow company, Platinum Coast, to apply for markers, or gambling loans, at three Las Vegas casinos in April and May.

``It was a bank error,'' Sadek says. ``No money ever left the account.''

Sadek holds up a copy of the marker application. It has his name at the top and his signature at the bottom. In the middle of the page is a bank-account number. He says he thought it was his personal account. It wasn't. It turned out to be Platinum Coast's, Sadek says.

He says he didn't know what he was signing.

To contact the reporter on this story: Bob Ivry in New York at bivry@bloomberg.net .

Last Updated: December 18, 2007 13:35 EST

Pimco's Gross Says U.S. Headed for `Mild' Recession (Update2)

By Kathleen Hays and Daniel Kruger

Dec. 18 (Bloomberg) -- Bill Gross, manager of the world's biggest bond fund, said the U.S. is headed for a ``mild'' recession in 2008 amid the worst housing slump in 16 years.

The economic contraction will be ``a mild one based upon housing and its ultimate handoff, I suppose, to the consumer,'' Gross said in an interview on Bloomberg Television. The U.S. economy will grow as little as 1 percent on average next year, he said.

Most analysts are more bullish on the economy than Gross. The economy will grow at a 2.3 percent rate on average next year, according to the median forecast of 62 analysts surveyed by Bloomberg from Dec. 3 to Dec. 10.

Gross reiterated his forecast that the Federal Reserve will have to keep lowering interest rates, after three cuts since Sept. 18, bringing the overnight benchmark rate to 4.25 percent.

Tomorrow's release of the results of the Fed's auction of $20 billion in 28-day funds will be a gauge of how much further the central bank needs to lower borrowing costs, he said. The Fed on Dec. 12 said it planned four such auctions to add cash to the banking system.

``You want to look at the amount that was bid for,'' he said. Should that tally reach $50 billion to $100 billion or more, ``that's a sign that conditions are tight.''

Auction Rate

At the same time, the higher the rate is that the banks offer for the loans, the greater the sign of distress in the financial system, Gross said. The minimum accepted bid set by the Fed was 4.17 percent.

Should the rate approach 4.75 percent, which is the level banks can borrow at directly from the Fed, it's a ``sign that in the United States we've got real liquidity problems,'' Gross said. The Fed cut its discount rate, as that direct lending rate is called, by a quarter-percentage point to 4.75 percent on Dec. 11.

Pimco, a unit of Munich-based insurer Allianz SE, manages about $721 billion.

Gross's $108 billion Total Return Fund has returned 7.43 percent this year through yesterday, according to Morningstar, the Chicago-based research firm. That return is ninth-best among the 352 distinct portfolios, excluding multiple share-classes, in the intermediate bond fund category, according to Morningstar. The average return for the group this year is 3.72 percent.

`Value' in Mortgages

The fund held 47 percent of its assets, weighted by duration, in mortgage-related debt as of Sept. 30, its largest concentration, according to Pimco's Web site. Debt maturing in less than a year accounted for 41 percent of assets. Bonds with a longer duration tend to be more sensitive in price to changing interest rates than shorter-duration securities.

Mortgage-backed securities guaranteed by government- chartered companies such as Fannie Mae and Freddie Mac ``offer very compelling value,'' Gross said yesterday in an interview posted on the firm's Web site.

The difference between the yield of 10-year Treasury notes and the 30-year current coupon Fannie Mae bond widened to 1.76 percentage point on Nov. 20, the most since January 2001, according to data compiled by Bloomberg.

In May Gross said he had made a ``mistake'' in the previous 12 months forecasting the Fed wouldn't lift rates as high as 5.25 percent, as the central bank did, and then again in predicting in October 2006 that the Fed would start cutting borrowing costs in the first half of this year.

To contact the reporter on this story: Kathleen Hays in New York at Khays4@bloomberg.net ; Daniel Kruger in New York at dkruger1@bloomberg.net

Last Updated: December 18, 2007 16:12 EST

Single-family housing starts hit 16-year low

Tue Dec 18, 2007 12:00pm EST WASHINGTON (Reuters)

Housing starts fell 3.7 percent in November, with construction of single-family homes sliding to the lowest level in more than 16 years as builders scrambled to cope with a deep drop in sales.

Home building projects started fell to an annual rate of 1.187 million units, the Commerce Department said on Tuesday in a report that was in line with expectations on Wall Street.

Starts on single-family homes tumbled 5.4 percent to an annual pace of 829,000 units, the lowest since April 1991. It was the eighth straight monthly drop in single-family starts.

In addition, permits for future building slipped 1.5 percent to their lowest level since June 1993.

Economists said the data underscored the degree to which the deep housing sector slump was weighing on the economy, which some analysts fear is teetering close to recession.

"The fourth quarter ... is going to have a substantial drag from the second leg down in construction, but the bright spot is that it's unlikely that we're going to see this rate of decline continue," said Michael Darda, chief economist at MKM Partners in Greenwich, Connecticut.

Prices of U.S. government bonds fell after release of the data, but traders largely focused on efforts by central banks to unfreeze credit markets, which have been drying up as defaults on U.S. mortgages have risen. U.S. stock markets were up slightly in late-morning trade.

Darda and other economists said the pullback in construction was needed for builders to work off a glut of unsold homes, a necessary step to the sector's recovery.

"The direct drag of housing on the economy will greatly diminish in 2008, but the (financial) market is more concerned on its indirect impact," said Richard DeKaser, chief economist at National City Corp in Cleveland, referring to the tightening of credit as U.S. mortgage defaults have risen.

RECESSION RISKS RISING

A Reuters poll released on Tuesday showed analysts see an increasing risk of a U.S. recession. The survey of 88 analysts put the chances of a recession in the next 12 months at 40 percent, up from 35 percent in a November poll.

The consensus view was that the economy would expand at a meager 0.9 percent pace in the fourth quarter, after moving ahead at a sprightly 4.9 percent clip in the third quarter. The economy was seen expanding a sluggish 2 percent in 2008.

The report on home construction showed single-family starts in both the Midwest and Northeast fell 20 percent. They dropped 6.8 percent in the West, but rose 5.4 percent in the South.

Over the past year, starts on both single and multiple-family units have plummeted 24.2 percent, while permits are down 24.6 percent.

Separate reports on chain store sales presented a mixed view on sales last week, but suggested holiday shopping was still subdued.

"Unfortunately, retailers were battered by several forces this past week, including storms and a procrastinating consumer," said Michael Niemira, chief economist for the International Council of Shopping Centers.

A joint report from ICSC UBS Securities said chain store sales slowed to a 2.1 percent year-on-year gain last week from 2.3 percent a week earlier.

Separately, Redbook Research said the year-on-year gain slipped to 1.3 percent from 1.6 percent in the prior week, well off last year's sales pace.

(Reporting by Joanne Morrison; Editing by Dan Grebler)

Rupert Murdoch Sees Recession, 5 Years of Real Estate Woes

Sunday, Dec. 16, 2007 10:10 p.m. EST

Rupert Murdoch, media tycoon and new owner of the Wall Street Journal, predicts that the U.S. faces a recession that will hit the overall economy and could undermine real estate for five or six years.
Appearing on Fox News' "Your World with Neil Cavuto," Murdoch admitted that he’s worried about the economy.

"I think we are in for a recession, probably. How bad it will be, I don't know. But I think there's a lot more bad news to come ...”

When Cavuto asked where the bad news will come from, Murdoch responded "European banks, insurance companies, pension funds."

He added that current woes "always start with housing booms."

"And it takes some time, a year or two, for an economy to come right through it, probably five or six years for the real estate market to come through it.”

Cavuto's asked, "Five or six years?"

Murdoch explained, "That has sort of been the history of these things in the '60s and the '80s.”

Murdoch suggested that banks will be back to normal in the near future. "I think in terms of banks cleaning up their balance sheets and getting back into lending and so on, I think that's only about a year or so," he said.

"The problem at the moment is, there is plenty of money everywhere, but the banks are frightened to lend it. And, therefore, it is harder for small-business men to get started. That's what have to watch, and the price of money. The banks are being so sort of super careful. They have had a big fright.”

Cavuto noted that prospective borrowers have also been frightened - that even those who would normally qualify relatively easily, are backing off, too.

Murdoch wasn't so sure.

"We just borrowed some money the other day," he said. "We're an investment grade company. And it was done on the telephone for $1 billion dollars. It was no trouble.”


Ending on a positive nore, Murdoch said "People talk. I was seeing the debates today, about jobs going overseas and so on. I thought disgraceful things. There is no one in America who wants a job who can't get one. We have got a state of very near full employment here. The country is doing pretty well.”


© NewsMax 2007. All rights reserved.

U.S. Homebuilder Confidence Unchanged at Record Low (Update1)

By Bob Willis

Dec. 17 (Bloomberg) -- Homebuilder confidence in the U.S. was unchanged at a record low in December, signaling falling home prices and a glut of unsold properties will extend the housing slump into 2008.

The National Association of Home Builders/Wells Fargo index of builder confidence was 19 as forecast for a third month, matching the lowest since records began in 1985, the Washington- based group said today. Levels lower than 50 mean most respondents view conditions as poor.

Builders are scaling back construction plans as falling sales cause inventories to pile up and foreclosures rise. Some potential homebuyers are holding out for bigger price declines, suggesting construction will continue to limit growth.

``There are not a lot of incentives for homebuilders to improve their outlook,'' said Douglas Smith, chief economist for the Americas at Standard Chartered Bank in New York, who forecast no change. ``In the near term, we shouldn't have a lot of high hopes.''

The forecast was based on the median estimate of 38 economists surveyed by Bloomberg News. Projections ranged from 17 to 21. The index averaged 42 last year.

Another report today showed the deficit in the U.S. current account, the broadest measure of trade because it includes transfer payments and investment income, narrowed to the smallest in two years, according to figures from the Commerce Department.

Asset Purchases

International buying of U.S. financial assets accelerated at the fastest pace in five months in October, the Treasury Department also announced.

The builder survey asks members to characterize current sales as ``good,'' ``fair'' or ``poor,'' and to gauge prospective buyers' traffic. The survey also asks participants to assess the outlook for the next six months.

A gain in perceptions of present and future sales was offset by a decline in the number of buyers visiting projects. The group's measure of single-family home sales rose to 19 from 18 the prior month. A measure of sales expectations for the next six months rose to 26 from 24. The index of buyer traffic declined to a record-low 14 from 17.

``There clearly are signs of stabilization,'' said David Seiders, chief economist at the National Association of Home Builders, in a statement. ``Many builders are bracing themselves for the winter months, when home buying traditionally slows.''

Regional Breakdown

Regionally, builders in the Northeast became more pessimistic, while sentiment improved in the Midwest and South.

The housing recession has taken a second leg down since the subprime-mortgage turmoil in August led to a worldwide credit shortage. In the third quarter, new foreclosures hit an all-time high, the Mortgage Bankers Association said in a report Dec. 6, putting more homes back on the market.

Senate passage of two bills last week improved some builders' outlook, the report said. One piece of legislation protected mortgage borrowers in foreclosure from getting a surprise tax bill, while the other made more Federal Housing Administration loans available to subprime borrowers threatened with losing their home.

Those actions ``are definitely a step in the right direction,'' Brian Catalde, president of the group and a builder from El Segundo, California, said in a statement. Combined with President George W. Bush's plan to freeze some subprime mortgage rates, ``these are essential measures for improving credit liquidity, restoring consumer confidence and reviving the overall housing market and economy,'' Catalde said.

Starts Forecast

A Commerce Department report tomorrow may show builders broke ground on new homes at an annual rate of 1.176 million in November, according to a Bloomberg survey. That would be the fewest since March 1993 and down from 1.229 million in October.

Housing starts in October were 46 percent below their Jan. 2006 peak, while new-home sales were down 48 percent from the record reached in July 2005. Sales and construction are likely to continue falling as long as inventories hold near record levels and prices tumble, economists said.

Home prices in the U.S. fell 4.5 percent in the third quarter from a year earlier, the most in at least two decades, according to the S&P/Case-Shiller home price index released Nov. 27. Lehman Brothers is forecasting prices will fall at least 15 percent from peak to trough.

Falling home prices leave Americans feeling less wealthy and thus less likely to spend or borrow against the equity in their homes. As declining home construction detracted from growth for the past seven quarters, falling prices may now weaken consumer spending. That is prompting some economists, including Richard Berner at Morgan Stanley, to project a recession next year.

Homebuilders are bracing for more bad news.

``This looks like it's going to be the deepest correction of any housing correction since World War II,'' Timothy Eller, chief executive officer of Centex Corp., the fourth-largest homebuilder, told a housing conference in Las Vegas on Nov. 27.

To contact the reporter on this story: Bob Willis in Washington at bwillis@bloomberg.net

Last Updated: December 17, 2007 13:28 EST

Fed Rate Cut Isn't Enough to Ease Housing Woes: John F. Wasik

Commentary by John F. Wasik


Dec. 17 (Bloomberg) -- The Federal Reserve's quarter-point cut of its benchmark rate to 4.25 percent last week looks like a big lump of coal in the stocking of the U.S. housing market.

While some buyers and refinancers may benefit, home prices may be headed for more declines in the most overheated markets, no matter what the Fed does.

As with most things in the financial world, home prices eventually had to regress to a historical rate of return. This realignment may eventually translate into a 15 percent nationwide decline, and even more in the markets with the highest appreciation and greatest supply.

Buried in the middle of the Office of Federal Housing Enterprise Oversight home-price report for the third quarter is an article on the relationship between areas that experienced the highest gains over the past half-decade and those facing higher-than-average foreclosures. Ofheo is the regulator of mortgage giants Freddie Mac and Fannie Mae.

As the U.S. housing market experienced its first quarterly decline in 13 years, Ofheo analysts observed that ``prices fell approximately 5.4 percent over the latest four quarters in the most foreclosure-prone areas, more than double the pace of price declines elsewhere.''

What happened in the most volatile markets? Home appreciation passed the threshold of economic reality, something the Fed can't restore by itself.

Rapid Descent

In 2004, Ofheo's Home Price Index exceeded a 30-year historical average price trend, eventually outpacing it by about 15 percent at the height of the bubble.

Where they were most out of line with average household income, home values are plummeting. The reasons for the rapid descent vary.

-- States such as Arizona, Nevada and Florida were boosted by overbuilding, cheap land, retiree relocations, population growth and rampant speculation.

-- California was burned because thousands of desperate homeowners did anything they could to buy houses in an already expensive market.

-- Ohio and Michigan were hurt by cutbacks in the U.S.- based auto industry.

Then there's the question of liquidity. Nothing will change in housing markets until prime borrowers have full access to credit and until the inventory of about 4.5 million listed but unsold homes drops significantly. Foreclosures also need to be curtailed.

Foreclosures Continue

Many bankers are shell-shocked. They don't want foreclosed properties on their books and have to sell them at steep discounts. That makes the housing market even more prone to price falls.

``As banks' capital needs increase, some may be forced to fire-sale the assets, further pressuring land prices,'' according to a November homebuilding survey by Zelman & Associates, a New York-based research firm.

The worst-rated areas, according to Zelman, are Atlanta; Detroit; Fort Myers, Jacksonville, Tampa and Southeast Florida; and Los Angeles, San Diego, San Bernardino and Riverside counties in California.

Little relief is on the horizon. New foreclosures reached a 20-year high in the third quarter, according to the Washington- based Mortgage Bankers Association.

One in five adjustable subprime borrowers fell behind on payments. That number may worsen as more resets are triggered next year.

Subprime Subterfuge

The five-year rate freeze on a minority of subprime loans proposed by President George W. Bush and Treasury Secretary Henry Paulson two weeks ago will buy some time for a fraction of the estimated 2 million homeowners facing foreclosure.

There's little substance to the Bush plan. It lacks force of law because it's voluntary. It does nothing to change federal-bankruptcy and mortgage-disclosure legislation or pave the way for unrestricted refinancing.

Only about 145,000 households are expected to be helped by the administration's plan, according to the Durham, North Carolina-based Center for Responsible Lending, a consumer group that monitors predatory lending.

Those whose mortgages have already reset to unaffordable monthly rates are trapped. Investors in those loans may not even agree to modifications.

``The heart of the problem,'' said Julia Gordon, policy counsel for the center, ``is securitization. Interests that were formerly aligned are not aligned now and there's no accountability.''

Fractured Dream

Since the highest-risk mortgages created little or no equity, borrowers and lenders had little financial stake in them.

Unless strong legislation gives borrowers the power to modify their loans, refinance, avoid prepayment penalties or stretch out payments, there's no reason to believe that the foreclosure crisis will end soon. These properties will continue to glut afflicted markets, lower prices and ruin neighborhoods.

Ultimately, the Fed's move will do little to restore equity to borrowers stuck in adjustable loans they can't afford, making homeownership a fractured dream.

Without equity creation -- which is essential in building real-estate wealth -- all you have is a very expensive place to rent.

(John F. Wasik, author of ``The Merchant of Power,'' is a Bloomberg News columnist. The opinions expressed are his own.)

To contact the writer of this column: John F. Wasik in Chicago at jwasik@bloomberg.net .

Last Updated: December 17, 2007 00:32 EST

Subprime Securities Market Began as `Group of 5' Over Chinese

By Mark Pittman

Dec. 17 (Bloomberg) -- Representatives of five of Wall Street's dominant investment banks gathered around a blonde wood conference table on a February night almost three years ago. Their talks over take-out Chinese food led to the perfect formula for a U.S. housing collapse.

The host was Greg Lippmann, then 36, a fast-talking Deutsche Bank AG trader who aspired to make mortgage securities as big a cash cow for Wall Street as the $12 trillion corporate credit market.

His allies included 34-year-old Rajiv Kamilla, a trader at Goldman Sachs Group Inc. with a background in nuclear physics, and 32-year-old Todd Kushman, who led a contingent from Bear Stearns Cos. Representatives from Citigroup Inc. and JPMorgan Chase & Co. were also invited. Almost 50 traders and lawyers showed up for the first meeting at Deutsche Bank's Wall Street office to help set the trading rules and design the new product.

``To tell you the truth, it's not very glamorous,'' Lippmann says. ``Just a bunch of guys eating Chinese discussing legal arcana.''

Those meetings of the ``group of five,'' as the traders called themselves, became a turning point in the history of Wall Street and the global economy.

The new standardized contracts they created would allow firms to protect themselves from the risks of subprime mortgages, enable speculators to bet against the U.S. housing market, and help meet demand from institutional investors for the high yields of loans to homeowners with poor credit.

Boom Turns Bust

The tools also magnified losses so much that a small number of defaulting subprime borrowers could devastate securities held by banks and pension funds globally, freeze corporate lending, and bring the world's credit markets to a standstill.

For a while, the subprime boom enriched investment bankers, lenders, brokers, investors, realtors and credit-rating companies. It allowed hundreds of thousands of Americans to buy homes they never believed they could afford.

It later became clear that these homeowners couldn't keep up with their payments. Defaults on subprime mortgages have so far produced about $80 billion in losses on securities backed by them. The market for the instruments is so opaque that many firms still aren't sure how much they've lost.

Chief executives at Citigroup, Merrill Lynch & Co. and UBS AG were replaced. To forestall a housing-led recession, the Federal Reserve has cut its benchmark rate three times since August and is injecting as much as $40 billion into the credit system to encourage banks to lend to each other.

`You Can't Wait'

This is the story of how Wall Street transmitted the practices of southern California's go-go lending industry and the inflated U.S. real estate market to the global financial system:

-- In Orange County, California, a mortgage lender named Daniel Sadek was among those who took notice of the increase in Wall Street's appetite for subprime loans. He turned the staff at his firm, Quick Loan Funding, into a subprime mortgage factory. ``You can't wait,'' said his ads, aimed at high-risk borrowers. ``We won't let you.''

-- In Dallas, a hedge-fund manager named Kyle Bass taught himself to use the contracts pioneered by Lippmann's group, then went looking for mortgage-backed securities to bet against. He found them in instruments based on loans Sadek made.

-- In New York, the ratings companies Standard & Poor's, Moody's Investors Service and Fitch Ratings put their stamp of approval on securities backed by loans to people who couldn't afford them. They used historical data to grade the securities and didn't adjust quickly enough for the widespread weakening of criteria used to qualify high-risk borrowers. Among the securities on which they bestowed investment-grade ratings: those backed by Sadek's loans.

`Robert Parker of Raw Fish'

Lippmann was a Wall Street renaissance man, with a strong appetite for sushi and an online restaurant guide so comprehensive one blogger labeled him ``the Robert Parker of raw fish.'' He opened the kitchen of the $2.3-million Manhattan loft he lived in then, complete with six burners, two grills and 20- foot island, to an Italian cooking class.

The goal of Lippmann's group on that winter evening in 2005: to design a new financial product that would standardize mortgage-backed securities, including those based on high-yield subprime loans, paving the way for their rapid growth. Of the firms participating that night, Lippmann's Deutsche Bank is based in Frankfurt, UBS in Zurich and the others in New York.

In February 2005, pension funds, banks and hedge funds owned fixed-income securities that were earning returns close to historic lows. AAA-rated securities based on home loans offered yields averaging a full percentage point higher than 10-year Treasuries at the time, according to Merrill.

Lure of Subprime

The trouble was that most creditworthy borrowers had already refinanced their houses at 2003's record-low mortgage rates. To meet demand for mortgage-backed securities, Wall Street had to find a new source of loans. Those still available mainly involved subprime borrowers, who paid higher rates because they were seen as credit risks.

While the group of five banks had packaged billions of dollars in subprime-based securities, in February 2005 none was among the leaders in the home-equity bond business. Countrywide Securities, RBS Greenwich Capital Markets, Lehman Brothers Holdings Inc., Credit Suisse Group and Morgan Stanley dominated the industry.

The banks wanted more mortgage-backed securities to sell to clients. Creating a standardized ``synthetic'' instrument, or derivative, would leverage small numbers of subprime mortgages into bigger securities. In this way, the firms could produce enough to meet global demand.

Building the Rocket

``We called up the guys we felt like we knew and could work with,'' Lippmann says.

Deutsche Bank sprang for the take-out food, and traders and lawyers sat down to design a new product and create what would soon become one of the hottest capital markets in the world.

The meetings were monthly, beginning at 5 p.m., after the trading day, and lasted more than three hours each.

``In the beginning, everybody brought their lawyer,'' says Lippmann.

Eventually, the Chinese food was replaced with deli fare because some participants complained it wasn't kosher.

The group sought to bring ``transparency,'' or openness, and ``liquidity,'' or trading volume sufficient to ensure ease of buying and selling, to the mortgage market.

The most important issues centered on how to account for the eccentricities of mortgage bonds, perhaps the most difficult-to-value securities on Wall Street. Unlike corporate bonds, home loans can be paid back at any time.

`Pay as You Go'

Traditionally, the best mortgage traders have been those who can read macro-economic trends to guess when homeowners will pre-pay their loans. Until recently, early repayment was perceived as the biggest risk faced by Wall Street's mortgage desks.

One concern with creating a standardized contract for mortgage-backed securities was that it was difficult to agree on a simple method of determining how market-changing events affected the values of the complicated, layered instruments.

To deal with the complexity, the group of five decided to install a ``pay-as-you-go'' system. When something happened affecting the cash flows underlying the security, the seller would have to make cash payments to the buyer immediately, and vice versa.

ISDA Steps In

As the group nailed down the details, the International Swaps and Derivatives Association, which sets trading terms for dealers, arranged conference calls including more of Wall Street.

To this point, some of the biggest mortgage underwriters -- Lehman Brothers, Merrill, Bank of America Corp. and Morgan Stanley -- hadn't been included in the negotiations. These firms heard about the talks and demanded to be let in.

On the conference calls, which included the market leaders, things got testy. One point in dispute was whether the contract should be traded on the basis of price or yield.

``Some of those points of detail were getting a little heated on the calls, and it was just thought it would be better to have a meeting face to face to move beyond those points,'' says Edward Murray, a London-based partner of the international law firm of Allen & Overy who was the chairman of the meeting and the outside counsel for ISDA. ``To be frank, the dealers that were not in the group of five were not that happy that there was a group of five.''

ISDA sought to resolve the differences by calling a sit- down meeting at its New York headquarters. Over coffee and pastries, Murray faced a crowd of dozens of traders and lawyers. Kamilla and Kushman acted as discussion leaders.

`Talk Was Very Firm'

``Rajiv would say something, and I'd be absolutely convinced about what he said,'' Murray says. ``And then Todd would say, `Well, I don't agree.' And I would be absolutely convinced about what Todd said. And then Rajiv would say `Well, the reason you're wrong is' and so on, et cetera.'' Kamilla and Kushman declined to discuss the negotiations.

Michael Edman, one of Morgan Stanley's representatives at the ISDA conference, was less chipper, Murray says.

``Arms folded, frown on his face, I'm not sure that's exactly true, but he wasn't in a happy-go-lucky mood,'' Murray says. ``There wasn't any shouting or anything, but the talk was very firm.'' Edman, who no longer works for Morgan Stanley, declined to comment.

By June, the differences were sorted out, the new contract was endorsed, and banks that hadn't been party to the group of five negotiations signed on. The banks would go on to create similar derivative contracts to trade securities backed by loans for commercial buildings and collateralized debt obligations, or CDOs, which are securities backed by various kinds of debt.

Creation of Index

Another necessary step was to create an index to represent the market and help hedge general market exposure. It was called the ABX-HE and would be similar to the indexes traders use for baskets of stocks. This, participants believed, would add to the market's liquidity, or depth, by attracting more trading.

By September 2005, some within Deutsche Bank were beginning to worry about defaults on subprime mortgages and how that might affect the securities based on them. A team of Deutsche Bank analysts that month warned of growing subprime market risks.

The ABX-HE index started trading on Jan. 19, 2006. At 8 a.m. on the first day, John Kane of Sorin Capital started phoning dealers. Kane, then 27, was a trader at Sorin, which runs hedge funds that invest in mortgages and other securities.

His auto mechanic, in describing the debt burden he was carrying to own a home, had planted the idea in Kane's mind that the housing market might be in trouble. Kane thought it through, ran an analysis on available data, and decided to wager against, or ``short,'' subprime. To do that, he turned to the portion of the ABX index dealing with the lowest investment-grade subprime securities.

Investors Go Short

The trouble was that quotes from brokers selling the ABX were already dropping, an indication that a number of investors wanted to do the same thing.

``All the other dealers were already scared'' and dropping their bids, Kane said while on a panel at a November industry conference. ``All but Goldman. So I bought from them.''

On its first day, the index traded more than $5 billion. The cost of wagering against the securities was rising, a sign that traders saw an increased chance of default. An early warning was visible to anyone who knew where to look.

The new derivatives were a hit among the group of five's customers -- the banks and other institutional investors that bought them to lock in high yields.

In the months to come, Deutsche Bank and at least one other member of the group of five, Goldman Sachs, began using subprime derivative contracts to bet the other way and guard against the possibility that subprime mortgages might default.

Lippmann Explains

For Lippmann's part, he says, it wasn't that he had ``any secret knowledge'' of the damaging events that were about to unfold in the U.S housing market. Rather, he says, he thought the risks of a downturn were significant enough to justify the millions of dollars it would cost to ``short,'' or wager against, subprime securities.

He says he told his bosses: ``If we're right, we're looking at a sixfold gain. And since a housing market slowdown is not as big a long shot as that, we should take the risk.''

Lippman disputes that the derivatives the group of five helped create -- which banks packaged into CDOs -- caused the subprime crisis.

``The problems in subprime are what they are and derivatives did not cause them,'' Lippmann says. ``Derivatives enabled more CDOs to be created and the stakes to be bigger. But the transparency made people realize the problem faster.''

Others see things differently. Derivatives, or ``synthetics,'' are ``like wearing a seatbelt that allows you to drive faster,'' says Rod Dubitsky, director of asset-backed research for Credit Suisse. ``The total dollar amount of losses, all these losses you're seeing, are from synthetics. No question, it changed the game dramatically.''

(TOMORROW: A California lender heeds Wall Street's call.)

To contact the reporter on this story: Mark Pittman in New York at mpittman@bloomberg.net

Last Updated: December 17, 2007 00:09 EST

U.S. Housing Crash Deepens in 2008 After Record Drop (Update2)

By Daniel Taub

Dec. 14 (Bloomberg) -- For U.S. homeowners, builders, bankers and realtors, the crash of 2007 will only get worse in 2008.

Everyone from mortgage-finance company Fannie Mae to Lehman Brothers Holdings Inc. expects declines next year. Existing home sales will drop 12 percent and existing home prices will fall 4.5 percent, Washington-based Fannie Mae says. Lehman analysts estimate almost 1 million mortgage loans will default in 2008, up from about 300,000 this year.

``We're only halfway through the housing shock,'' said Ethan Harris, chief U.S. economist at New York-based Lehman, the fourth- biggest U.S. securities firm by market value. ``It's just a matter of time before the weakness spreads to the rest of the economy.''

The housing market collapse has been anything but the ``soft landing'' that Federal Reserve Bank of San Francisco President Janet Yellen and David Lereah, former chief economist at the National Association of Realtors in Chicago, predicted for real estate at the start of 2007.

Median home prices declined in the U.S. this year, the first annual drop since the Great Depression, according to forecasts from the National Association of Realtors.

``I'm not going to sit here and tell you it's going to turn real strong next year,'' said Jim Gillespie, chief executive officer of Coldwell Banker Real Estate LLC, the largest U.S. residential brokerage, according to Franchise Times. ``It's not going to turn real strong next year.'' Gillespie said he doesn't make housing market forecasts.

`Let the House Go'

Analysts at New York-based CreditSights Inc. predict housing won't rebound until ``2009, at best.'' Moody's Economy.com Inc., the economic forecasting unit of Moody's Corp. in New York, says home sales will hit bottom next year, declining 40 percent from their peak. And U.S. Treasury Secretary Henry Paulson's plan to slow foreclosures won't help those who already are facing the loss of their homes, like C.W. and Sandy Hicks of Las Vegas.

The Hickses refinanced the mortgage on their four-bedroom, 1,300-square foot home two years ago. Their $237,000 adjustable- rate loan resets every month, and now their monthly payment has jumped 50 percent to $2,700. The couple can't afford it.

``It looks like we're going to have to let the house go,'' said C.W. Hicks, 65, a long-haul truck driver who has kept working past retirement age to help pay medical bills for his wife Sandy, 59, who has heart problems. ``I guess we'll try to rent a house or something.''

The Hickses aren't the only ones grappling with the consequences of this year's housing market. The number of Americans behind on their mortgage payments rose to a 20-year high in the third quarter, the Washington-based Mortgage Bankers Association said earlier this month.

Lender, Homebuilder Woes

``The whole thing has deteriorated faster and further than we or anyone else had anticipated,'' said Ron Muhlenkamp, president of Wexford, Pennsylvania-based Muhlenkamp & Co., which has about $2.5 billion under management and holds shares of mortgage lender Countrywide Financial Corp. and homebuilder Ryland Group Inc.

The five biggest U.S. homebuilders by revenue, led by Miami- based Lennar Corp., recorded writedowns and charges totaling about $7.5 billion this year for land that plunged in value.

Mortgage companies, including Irvine, California-based New Century Financial Corp., the second-largest subprime lender in 2006, have filed for bankruptcy protection after borrowers unable to repay their loans defaulted.

H&R Block Inc. of Kansas City, Missouri, shut Option One this month after plans to sell the subprime home-lending unit fell apart, and U.S. regulators ordered Santa Monica, California-based Fremont General Corp. to stop selling subprime mortgages, loans given to people with poor or limited credit histories or high debt levels.

O'Neal, Prince Fall

Bank and brokerage writedowns and losses related to subprime loans totaled more than $80 billion. Citigroup Inc., the biggest U.S. bank by assets, last month said it would write down the value of subprime mortgages and collateralized debt obligations -- securities backed by bonds and loans -- by $8 billion to $11 billion. At Merrill Lynch & Co., writedowns on mortgage-related investments and corporate loans have cost the world's biggest brokerage $8.4 billion. Both companies are based in New York.

The losses led to the ouster of Merrill Chief Executive Officer Stan O'Neal and the resignation of Citigroup CEO Charles O. ``Chuck'' Prince III. O'Neal's exit came after he said as late as July that ``not even a sharp downturn in one market today necessarily portends financial disaster in another, and we're seeing this play out today in the subprime market.''

U.K., Canada

Fallout from the subprime crisis in the U.S. has crimped economic expansions in the U.K., Canada and Germany.

Investment in U.K. commercial real estate may slump 60 percent in the fourth quarter as buyers shun large acquisitions of shops and offices, Chicago-based Jones Lang LaSalle Inc., the world's second-largest property brokerage, said Dec. 10.

Spending on British commercial real estate, Europe's largest investment market, may decline in the final three months of the year to 5 billion pounds ($10.2 billion) from 18.6 billion pounds a year earlier, Jones Lang said in a statement. Investment for all of 2007 may fall 24 percent to about 48 billion pounds.

Falling prices are already hurting U.K. property funds. New Star Asset Management Group Ltd., the fund company founded by John Duffield, said earlier this week that value of its U.K. commercial property mutual fund was cut by 8.2 percent after the value of its buildings dropped 18 percent since July.

Market lending rates rose worldwide in the past month as writedowns linked to subprime defaults heightened concerns about the strength of financial institutions.

Anxiety Continues

``Until the public is convinced that the subprime credit exposure has been identified, quantified and dealt with, there will continue to be anxiety,'' said Todd Canter, international director at LaSalle Investment Management in Baltimore, where he helps manage about $11 billion in real estate stocks. ``There will continue to be volatility in the marketplace.''

Some economists and real estate executives say the industry may be on the verge of turning around. Lawrence Yun, chief economist at the National Association of Realtors, said ``we are touching the bottom'' for existing-home sales. Coldwell Banker's Gillespie said demographic and economic changes, such as rising immigration and employment, will help boost home sales.

``People buy for lifestyle, and there's a lot of pent-up demand out there,'' Gillespie said.

Offices, Apartments

U.S. office sales fell 70 percent in October from a year ago, industrial sales declined 24 percent, and retail and apartment sales dropped 50, according to New York-based research firm Real Capital Analytics Inc. The declines are the biggest since the company began keeping records in 2001.

The 128-member Bloomberg REIT Index rose 62 percent in the two years ended Feb. 8, the day before New York-based Blackstone Group LP bought Equity Office Properties Trust for $39 billion, including debt, in the real estate industry's biggest leveraged buyout. The index has dropped 26 percent since then.

``You're not seeing the Equity Office transactions anymore,'' said Dan Fasulo, Real Capital's managing director for research. ``It's extremely difficult right now to finance the large portfolio transaction and privatizations we've seen over the last couple of years. I can't even think of one major privatization that has been announced since the credit crunch.''

Mission West Properties Inc., owner of almost 8 million square feet of Silicon Valley commercial buildings, disclosed talks in July with a private equity firm about being acquired. The Cupertino, California-based company said a month later the sale might fail after a bank withdrew funding. Mission West then said in October that there remained three potential bidders. A transaction hasn't yet been announced.

Sales Delayed

Highwoods Properties Inc., the owner of almost 34 million square feet of commercial space, said last month that it no longer expects to sell properties in Winston-Salem, North Carolina, totaling 1.6 million square feet. The company cited ``volatility of the capital markets'' as the reason the sale didn't go through.

``I know we weren't predicting things would get this bad,'' said Frank Liantonio, executive vice president for global capital markets at New York-based Cushman & Wakefield Inc., the largest closely held real estate services provider. ``There were some signs there, but I don't think anyone anticipated the level of dislocation that was actually created.''

To contact the reporter on this story: Daniel Taub in Los Angeles at dtaub@bloomberg.net

Last Updated: December 14, 2007 17:28 EST

The down-payment-poor are about to get squeezed

Kenneth Harney -- Nation's Housing, December 9, 2007. baltimoresun.com

Call it the credit risk hangover following the housing boom binge: Homebuyers and refinancers who can't come up with sizable down payments, and whose FICO credit scores are below 680, are about to get squeezed in the mortgage market.

Giant investors Fannie Mae and Freddie Mac are imposing significant increases in fees for a broad range of borrowers who have lower than 30 percent down payments and formerly were treated as "prime" credit applicants.

At the same time, the two largest private mortgage insurers -- MGIC Corp. and PMI Group -- are raising premiums on consumers who have low down payments and FICO scores in the mid to upper 600s.

The added costs for some potential homebuyers could mount into the thousands of dollars -- either up front at settlement or in the form of higher interest rates. Each of the companies says it has experienced unexpectedly high losses on loans with these characteristics and must now revise prices upward to handle the elevated risks. But some mortgage bankers and brokers say the higher costs and down payments will make homeownership impossible or very difficult for a large number of borrowers, and slow any future housing market recovery.

Though Fannie Mae's and Freddie Mac's revised fees won't take effect until March 1, major lenders who sell loans to the two investors began imposing the surcharges on applicants at the beginning of December. Some mortgage loan officers are upset that clients with FICO scores close to 700 -- far above the once-traditional 620 cutoff point between "prime" and "subprime" -- are now being charged more.

"This is outrageous," said Steven Moore, a mortgage broker with 1st Solution Mortgage in Falls Church, Va. "On a loan of $300,000 and with a credit score of 675 -- which is not a bad score -- and a 75 percent loan-to-value ratio (25 percent down payment), the cost is an additional $2,250 per loan."

If the same borrower wants to do a cash-out refinancing to consolidate debt, the new Fannie-Freddie fee schedule will add another $1,500 to total costs on a $300,000 mortgage, said Moore. On a $400,000 loan, he estimates the extra fees would total $5,000.

Jeff Lipes, president of Family Choice Mortgage in Wethersfield, Conn., said the new emphasis on higher FICO scores and larger down payments could greatly complicate rate quotations. "To get any sort of quote, you're going to need to know your FICO score in advance and, before actually applying, you may need to take some steps to raise your FICO score."

Under previous standards, applicants with scores comfortably above 620 "could reasonably assume" they would qualify for a good rate, said Lipes. "But now we've got this whole new gray area between 620 and 680" FICOs under the revised Fannie/Freddie risk-based pricing guidelines. Joint applicants where one spouse or partner has a FICO score below the new guidelines will need to take special care, according to Lipes, so as not to trigger higher credit-risk fees.

Lipes predicts loan officers and brokers will make far greater use of so-called "rapid rescoring" services offered by some local credit bureaus to increase applicants' scores legally by correcting errors, lowering debt utilization ratios on credit card accounts and other techniques.

Here's a quick overview of the new policies from Fannie and Freddie affecting loan applications where the down payment amount is less than 30 percent: If the borrower's credit score is less than 620, a new 2 percent fee will be imposed. If the score is between 620 and 639, the surcharge will be 1 3/4 percent. If it is between 640 and 659, the add-on will be 1 1/4 percent. On scores between 660 and 679, the surcharge will be three-fourths of 1 percent.

According to mortgage banker Lipes, if applicants choose to roll the higher fees into the interest rate on the mortgage, the new Fannie/Freddie charges generally will increase rates by anywhere from one-eighth to one-half of 1 percent.

The MGIC mortgage insurance premium increases, which were scheduled for announcement the first week of December, are expected to have the heaviest impacts on borrowers making down payments of less than 3 percent and whose FICO scores are below 660, according to company officials. On such loans, MGIC is expected to raise premiums to 1.7 percent per $100,000 of loan amount, up from the current premium level of 0.96 percent. On a $200,000 mortgage, that would raise the annual premiums from $1,920 to $3,400.

The PMI Group's increased premium levels, which have already taken effect, are roughly similar, but the company also announced that it will no longer insure any mortgages where the down payment is less than 5 percent and the borrower's FICO score is below 620.

kenharney@earthlink.net

Foreclosures.com sees 93% rise in foreclosure filings

Number of REO properties up 41% from a year ago
Thursday, December 13, 2007

Inman News

Initial foreclosure filings rose 93 percent from January through November compared to the same period last year, foreclosure research company Foreclosures.com reported this week, and the number of homes that ended up as bank-owned properties rose 41 percent.

An estimated 1.08 million homes, or 14.8 of every 1,000 households, entered the foreclosure process nationwide in the first 11 months of the year. And 526,936 households, or 6.6 homes out of every 1,000 households, reverted to lender ownership.

An estimated 72,101 homes nationwide were repossessed by lenders in November alone, up 31.8 percent compared to October. Bank-owned properties are also known as real estate-owned, or REO, properties.

The Foreclosures.com statistics are based on an analysis of the number of formal notices filed against a property in the foreclosure process. The company noted that depending on the location and laws, there can be two to three filings per property, including notice of default and/or notice of foreclosure auction, and notice of REO or bank-owned real estate, which happens after a foreclosed property fails to sell at auction and reverts back to the lender.

Not all pre-foreclosures end up as REO properties because some homeowners may avoid foreclosure through short sales or other workouts with lenders, for example.

The Mortgage Banker Association reported earlier this month that the rate of foreclosure starts and the percentage of loans in foreclosure during the third-quarter reached record highs, and the delinquency rate on all loans rose 47 basis points from the second quarter to 5.59 percent -- the highest level since 1986.

And foreclosure data company RealtyTrac reported that nationwide foreclosure filings jumped 94 percent in October compared to October 2006.

Alexis McGee, president of Foreclosures.com, said in a statement that there are "pockets of actual drops in the number of foreclosure and pre-foreclosure filings from a year ago," despite the national increase.

"More foreclosures isn't an unexpected trend as greater numbers of overextended homeowners facing tightened credit run out of options to foreclosure," she stated. "The housing financial crunch could ease a bit, but only time will tell just how much of an effect and how many homeowners will be helped by the various workout options to be made available."

The company reported statistics for REOs by region, per capita, in January-November 2007 compared to the same period in 2006:


In the Midwest (Illinois, Indiana, Michigan, Minnesota, Missouri, Ohio and Wisconsin) there was a rate of 8.8 foreclosure filings per 1,000 households, up 23.9 percent.


In the Southwest (including Arizona, California, Colorado, Nevada, New Mexico, Oregon, Texas and Washington), the rate was 8.3 filings per 1,000 households, up 72.9 percent.


In the Southeast (including Alabama, Arkansas, Florida, Georgia, Kentucky, Mississippi, Tennessee and Virginia): the rate was 7.1 filings per 1,000 households, up 31.5 percent.


In other states (including Alaska, Hawaii, Idaho, Montana and Utah) the rate was 6.2 REOs per every 1,000 households, down 1.6 percent.


In the Northeast (includes Connecticut, New Jersey, New York, Massachusetts, Maryland, Pennsylvania and Washington, D.C.), the rate was 1.4 filings per 1,000 households, up 7.7 percent.

REOs by the top-10 states per capita in January-November 2007 vs. the same period last year:


Nevada had 16.7 filings per 1,000 households in January-November 2007 vs. 6.2 for every 1,000 households during that period in 2006.


Colorado had 16.3 filings per 1,000 households during that period in 2007 vs. 20.9 for every 1,000 households during that period in 2006.


Michigan had 15.4 filings per 1,000 households during January-November 2007 vs. 10.2 during that period in 2006.

***

Interest rate 'freeze' - the real story is fraud

MORTGAGE MELTDOWN
Bankers pay lip service to families while scurrying to avert suits, prison

Sean Olender
San Francisco Chronicle
Sunday, December 9, 2007

New proposals to ease our great mortgage meltdown keep rolling in. First the Treasury Department urged the creation of a new fund that would buy risky mortgage bonds as a tactic to hide what those bonds were really worth. (Not much.) Then the idea was to use Fannie Mae and Freddie Mac to buy the risky loans, even if it was clear that U.S. taxpayers would eventually be stuck with the bill. But that plan went south after Fannie suffered a new accounting scandal, and Freddie's existing loan losses shot up more than expected.

Now, just unveiled Thursday, comes the "freeze," the brainchild of Treasury Secretary Henry Paulson. It sounds good: For five years, mortgage lenders will freeze interest rates on a limited number of "teaser" subprime loans. Other homeowners facing foreclosure will be offered assistance from the Federal Housing Administration.

But unfortunately, the "freeze" is just another fraud - and like the other bailout proposals, it has nothing to do with U.S. house prices, with "working families," keeping people in their homes or any of that nonsense.

The sole goal of the freeze is to prevent owners of mortgage-backed securities, many of them foreigners, from suing U.S. banks and forcing them to buy back worthless mortgage securities at face value - right now almost 10 times their market worth.

The ticking time bomb in the U.S. banking system is not resetting subprime mortgage rates. The real problem is the contractual ability of investors in mortgage bonds to require banks to buy back the loans at face value if there was fraud in the origination process.

And, to be sure, fraud is everywhere. It's in the loan application documents, and it's in the appraisals. There are e-mails and memos floating around showing that many people in banks, investment banks and appraisal companies - all the way up to senior management - knew about it.

I can hear the hum of shredders working overtime, and maybe that is the new "hot" industry to invest in. There are lots of people who would like to muzzle subpoena-happy New York Attorney General Andrew Cuomo to buy time and make this all go away. Cuomo is just inches from getting what he needs to start putting a lot of people in prison. I bet some people are trying right now to make him an offer "he can't refuse."

Despite Thursday's ballyhooed new deal with mortgage lenders, does anyone really think that it can ultimately stop fraud lawsuits by mortgage bond investors, many of them spread out across the globe?

The catastrophic consequences of bond investors forcing originators to buy back loans at face value are beyond the current media discussion. The loans at issue dwarf the capital available at the largest U.S. banks combined, and investor lawsuits would raise stunning liability sufficient to cause even the largest U.S. banks to fail, resulting in massive taxpayer-funded bailouts of Fannie and Freddie, and even FDIC.

The problem isn't just subprime loans. It is the entire mortgage market. As home prices fall, defaults will rise sharply - period. And so will the patience of mortgage bondholders. Different classes of mortgage bonds from various risk pools are owned by different central banks, funds, pensions and investors all over the world. Even your pension or 401(k) might have some of these bonds in it.

Perhaps some U.S. government department can make veiled threats to foreign countries to suggest they will suffer unpleasant consequences if their largest holders (central banks and investment funds) don't go along with the plan, but how could it be possible to strong-arm everyone?

What would be prudent and logical is for the banks that sold this toxic waste to buy it back and for a lot of people to go to prison. If they knew about the fraud, they should have to buy the bonds back. The time to look into this is before the shredders have worked their magic - not five years from now.

Those selling the "freeze" have suggested that mortgage-backed securities investors will benefit because they lose more with rising foreclosures. But with fast-depreciating collateral, the last thing investors in mortgage bonds ought to do is put off foreclosures. Rate freezes are at best a tool for delaying the inevitable foreclosures when even the most optimistic forecasters expect home prices to fall. In October, Goldman Sachs issued a report forecasting an incredible 35 to 40 percent drop in California home prices in the coming few years. To minimize losses, a mortgage bondholder would obviously be better off foreclosing on a home before prices plunge.

The goal of the freeze may be to delay bond investors from suing by putting off the big foreclosure wave for several years. But it may also be to stop bond investors from suing. If the investors agreed to loan modifications with the "real" wage and asset information from refinancing borrowers, mortgage originators and bundlers would have an excuse once the foreclosure occurred. They could say, "Fraud? What fraud?! You knew the borrower's real income and asset information later when he refinanced!"

The key is to refinance borrowers whose current loans involved fraud in the origination process. And I assure you it was a minority of borrowers whose loans didn't involve fraud.

The government is trying to accomplish wide-scale refinancing by tricking bond investors, or by tricking U.S. taxpayers. Guess who will foot the bill now that the FHA is entering the fray?

Ultimately, the people in these secret Paulson meetings were probably less worried about saving the mortgage market than with saving themselves. Some might be looking at prison time.

As chief of Goldman Sachs, Paulson was involved, to degrees as yet unrevealed, in the mortgage securitization process during the halcyon days of mortgage fraud from 2004 to 2006.

Paulson became the U.S. Treasury secretary on July 10, 2006, after the extent of the debacle was coming into focus for those in the know. Goldman Sachs achieved recent accolades in the markets for having bet heavily against the housing market, while Citigroup, Morgan Stanley, Bear Sterns, Merrill Lynch and others got hammered for failing to time the end of the credit bubble.

Goldman Sachs is the only major investment bank in the United States that has emerged as yet unscathed from this debacle. The success of its strategy must have resulted from fairly substantial bets against housing, mortgage banking and related industries, which also means that Goldman Sachs saw this coming at the same time they were bundling and selling these loans.

If a mortgage bond investor sues Goldman Sachs to force the institution to buy back loans, could Paulson be forced to testify as to whether Goldman Sachs knew or had reason to know about fraud in the origination process of the loans it was bundling?

It is truly amazing that right now everyone in the country is deferring to Paulson and the heads of Countrywide, JPMorgan, Bank of America and others as the best group to work out a solution to this problem. No one is talking about the fact that these people created the problem and profited to the tune of hundreds of billions of dollars from it.

I suspect that such a group first sat down and tried to figure out how to protect their financial interests and avoid criminal liability. And then when they agreed on the plan, they decided to sell it as "helping working families stay in their homes." That's why these meetings were secret, and reporters and the public weren't invited.

The next time that Paulson is before the Senate Finance Committee, instead of asking, "How much money do you think we should give your banking buddies?" I'd like to see New York Sen. Chuck Schumer ask him what he knew about this staggering fraud at the time he was chief of Goldman Sachs.

The Goldman report in October suggests that rampant investor demand is to blame for origination fraud - even though these investors were misled by high credit ratings from bond rating agencies being paid billions by the U.S. investment banks, like Goldman, that were selling the bundled mortgages.

This logic is like saying shoppers seeking bargain-priced soup encourage the grocery store owner to steal it. I mean, we're talking about criminal fraud here. We are on the cusp of a mammoth financial crisis, and the Federal Reserve and the U.S. Treasury are trying to limit the liability of their banking friends under the guise of trying to help borrowers. At stake is nothing short of the continued existence of the U.S. banking system.

Sean Olender is a San Mateo attorney. Contact us at insight@sfchronicle.com.

http://sfgate.com/cgi-bin/article.cgi?f=/c/a/2007/12/09/IN5BTNJ2V.DTL

This article appeared on page C - 1 of the San Francisco Chronicle

Mortgage Pain Hits Prudent Borrowers

Fannie Adds More Fees on Loans -- Even for Home Buyers
With Good Credit; 'Jumbo' Rates Resume Upward Trend
By JAMES R. HAGERTY and RUTH SIMON
December 11, 2007; Page B9

Some of the costs of cleaning up the nation's mortgage crisis are beginning to hit innocent bystanders: people who pay their bills on time and avoid excessive debt.

Fannie Mae, the giant government-sponsored mortgage investor, last week raised costs for many borrowers by quietly adding a 0.25% up-front charge on all new mortgages that it buys or guarantees. On a $400,000 mortgage, that would mean an extra $1,000 in fees, almost certain to be passed on to the consumer. Freddie Mac, the other big government-sponsored mortgage investor, is expected to impose a similar fee soon, according to a person familiar with the situation.

The new charge from Fannie Mae adds to the general gloom over the housing market. It comes as mortgage interest rates are heading up again after a recent dip -- as well as increases in mortgage-insurance costs, tougher requirements on down payments and other moves by lenders to ration credit. And last month, Fannie and Freddie imposed surcharges for mortgage borrowers with lower credit scores.

Loan applications have been so slow lately, says Lou Barnes, a mortgage banker in Boulder, Colo., that it feels like "our client base today is limited to people who don't read the newspaper or watch television."

Still, mortgage loans remain available for many people at rates that are attractive by historical standards. People with good credit scores and enough savings to pay a substantial down payment can still get 30-year fixed-rate mortgages of as much as $417,000 for 6.14% on average, according to HSH Associates, a financial-publishing firm in Pompton Plains, N.J.

But so-called jumbo loans -- those above $417,000, the ceiling on mortgages that can be bought or guaranteed by Fannie and Freddie -- have become much more expensive in relation to smaller mortgages.

The average rate for a fixed-rate jumbo loan is 7.13%, according to HSH. That is down from a recent high of 7.46% but remains lofty in comparison with "conforming" loans, those that can be sold to Fannie or Freddie. The premium paid for jumbo loans ballooned in August, when many loan investors began shunning mortgages lacking a guarantee from Fannie or Freddie.

Fannie said its new 0.25% fee will apply to loans sold by lenders to Fannie or placed into pools of guaranteed loans backing mortgage securities as of March 1, 2008. Lenders are likely to start adding that fee over the next few weeks because there is often a delay of several months between loan terms being offered to consumers and the sale of a completed loan to Fannie.

In a statement, Fannie said the new fee is needed "to ensure that what we charge aligns with the risk we bear." The National Association of Home Builders labeled the fee "a broad tax on homeownership." More than 40% of all mortgages outstanding are owned or guaranteed by Fannie or Freddie.

The fee is the latest in a series of moves by Fannie and Freddie that raise the cost of credit for some borrowers. Late last month, they imposed surcharges that affect mortgage borrowers who have credit scores below 680, on a standard scale of 300 to 850, and who are borrowing more than 70% of a property's value. For example, someone with a credit score of 650 would pay a surcharge of 1.25% of the loan amount for a mortgage to be sold to Fannie. On a $300,000 loan, that would mean extra fees of $3,750. The fee could be paid in cash or in the form of a higher interest rate than would normally apply.

SPREADING FALLOUT

The mortgage crisis has begun pinching even borrowers with good credit ratings. Here's what is happening:

• Fannie Mae has imposed an extra charge on all new loans it buys or guarantees.

• Mortgage insurers have raised premiums for certain borrowers and tightened standards.

• Borrowers with good credit scores and equity in their homes can still get attractive rates from lenders.Fannie also is raising down-payment requirements for loans it purchases or guarantees in places where house prices are falling, which by some measures is most of the country. In these declining markets, lenders will need to cut by five percentage points the maximum percentage of the home's estimated value that can be financed. For instance, for types of loans that Fannie normally would allow to cover up to 100% of the estimated value, the ceiling now is 95% in declining markets.

Standards continue to tighten in other areas. Lenders that make the largest loans and offer the best rates to borrowers seeking jumbo mortgages want borrowers to show not only a good credit score but also enough reserves to cover as much as three years of mortgage payments and carrying costs, says Melissa Cohn, a mortgage broker in New York. Borrowers taking out interest-only loans are being qualified based on their ability to make the full payment once the interest-only period ends and not just the lower initial payment, she says.

Lenders in recent months have sharply scaled back on loans that don't require the borrower to make a down payment or provide proof of income and savings. The bar for credit scores is rising, too. "Historically, lenders would consider top-tier credit [a score of] 680," says David Soleymani, a mortgage broker in Los Angeles. "Now, many of those lenders want to see a 720," but are rewarding such borrowers with better rates, he says.

Mortgage insurers are also raising their prices and tightening their standards. Mortgage insurance is typically required when a borrower finances more than 80% of a home's value. During the peak of the housing boom, many borrowers got around this requirement by taking out a so-called piggyback mortgage, which combined a mortgage with a home-equity loan or line of credit. But demand for mortgage insurance has climbed as most lenders have stopped promoting piggyback loans.

Triad Guaranty Insurance Corp., Winston-Salem, N.C., this month stopped providing mortgage insurance on option adjustable-rate mortgages, which carry low introductory rates but can lead to a rising loan balance. Triad also said it would no longer provide mortgage insurance for loans that exceed 97% of a home's value. It set a 90% threshold for loans in four states where home prices have been dropping fast: Arizona, California, Florida and Nevada. "We want to look for people who have more equity rather than less equity" in their homes, says Triad Vice President Jerry Schwartz.

PMI Group Inc., a Walnut Creek, Calif., mortgage insurer, this fall stopped writing mortgage insurance for borrowers with credit scores below 620 who are financing more than 95% of their home's value. PMI also has boosted prices for most borrowers who have credit scores of 620 and higher with loan-to-value ratios above 95%. Borrowers with credit scores between 620 and 659 who are financing more than 97% of their home's value face the biggest increase. The monthly premium for a $200,000 mortgage will increase by $123 to $283.

Starting next month, MGIC Investment Corp. will no longer insure loans when income and assets aren't fully documented unless borrowers can show they are self-employed and are either buying a home they intend to live in or are refinancing the mortgage on their home without pulling cash out. MGIC also will no longer insure loans in California and Florida where the borrower has less than 5% equity and is raising premiums for certain borrowers. "This is the first significant price change since the mid-1980s," says Michael Zimmerman, MGIC's vice president of investor relations.

With standards tightening, some borrowers who might previously have looked for a subprime mortgage or 100% financing are turning to loans guaranteed by the Federal Housing Administration, which for a fee insures mortgages as much as $362,790. Peter Lansing, a mortgage banker in Denver, says that FHA loans accounted for more than half of his business last month, compared with less than 10% a year ago.

Write to James R. Hagerty at bob.hagerty@wsj.com and Ruth Simon at ruth.simon@wsj.com

Economy Calls for a Big Rate Cut

Newsmax.com

I have just returned from a week talking with bankers in England and in Switzerland.

In Basel, I had an illuminating — but “off-the-record” — interview with the Bank of International Settlements (BIS), the important research and coordination working body for the world’s Central Bankers.

Although the initial positions presented by those whom I visited were to some degree less bearish than my own, I have to say that their confidential, final views began to approach my own, albeit they were seasoned with a hope that things would not unwind so drastically.

In summary, I picked up a certain sense of quiet pessimism, more in line with my own views.

Now back home in the United States, I saw The Wall Street Journal front page headline, “U.S. Mortgage Crisis Rivals S&L Meltdown.”

As The Wall Street Journal article points out, there have been five major debt crises since World War II.

They started in 1982 with the bank lending crisis, of which I warned in a speech in the House of Commons in 1980. It amounted to $55 billion, or 1.7 percent of gross domestic product (GDP).

This was followed by the Savings and Loan crisis. That amounted to $189 billion, or 3.2 percent of the then-GDP, but ominously lasted almost nine years, from 1986 to 1995.

The Japanese bank-lending crisis totaled $263 billion, or 7 percent of GDP, and lasted 11 years, from 1992 to 2003. It is most important to realize that Japan has still not yet recovered from the subsequent economic slump, triggered by a revaluation of its currency.

In 2000 to 2003, we experienced what became known as the dot-com bust. It was only $93 billion, a tiny 0.9 percent of GDP, but nevertheless a painful memory for many investors.

Today, the subprime mortgage crisis is estimated to be some $150 to $400 billion. That makes it 1 to 3 percent of GDP.

However, unlike the previous bank crises, our present subprime crisis is still running and looking worse by the day.

Indeed, only today, UBS – the largest money manager in the world – announced a second hit, this time for $10 billion.

This despite the fact that UBS has obtained a cash infusion. Pretty soon you’re talking real money, even for a major Swiss bank.

Today, Bank of America said it is closing its $12 billion money market fund because of losses in structured investment vehicles (SIVs)! Investors will receive less than par — from a money market!

When I warned our readers to be wary of money market funds that had invested in SIVs, some readers thought I was being unnecessarily alarmist. I was merely trying to warn our readers.

Looking at The Wall Street Journal article, I am struck not by the relatively small percentage of comparative GDP but by both the absolute size and complexity of the “toxic waste” within the subprime crisis and by the fact that it is both worldwide and held by unrelated investors, including Norwegian townships within the Arctic Circle!

This is causing a very dangerous credit crisis, affecting all but the most prime borrowers.

In addition, the size of our present problem, estimated at $150 to 400 billion, is still growing.

I believe that President Bush’s idea to freeze certain qualifying ARM re-sets is not an order but merely a suggestion! I fear that it will not work and that, by the time our subprime crisis is over, it will be recorded to have been well over the highest estimate of 3 percent of GDP.

In short I see daily, growing evidence that we are entering a recession. Those who disagree are growing increasingly desperate in their efforts to drown out that view and deny the opportunity to express it.

Not that I am the only economist to believe we are fast entering a recession. Far from it — at least for now!

But, by denying the free expression of opinion, our government risks making decision based upon false assumptions.

For instance, the Fed is due to make a crucial interest rate decision Tuesday.

The general expectation is for a quarter to a half-point cut. Indeed, the recent headline inflation number — without looking at the continued decline of manufacturing and construction jobs, inside the figures — may well give our Fed the excuse to lower rates by only a quarter of a point.

Here it is interesting to note that last week, both the British and the Canadians dropped their rates by a quarter-point. Sadly and despite calls from grass roots, the European Central Bank kept its Euro rate on hold.

I have often said that, depending upon the phase of the economic cycle and the shape and level of the yield curve, it can take between nine and 24 months for a Fed rate change to gain economic traction.

To divert our pending economic recession from morphing into a severe recession or worse will require a Fed interest rate cut to 1 percent or less. In saying this, I agree with bond fund manager Bill Gross of Pimco.

Even a half-point rate cut tomorrow will prove to be far too little and too late to meet the hopes of my friends the English and Swiss bankers, that a catastrophy will be avoided.

If the Fed does cut its key rates by half a point tomorrow, stock markets can be expected to rise. It will be a false dawn.

Beware of more 'hidden' subprime losses

HERB GREENBERG
Commentary: Report says Washington Mutual, Countrywide most vulnerable
By Herb Greenberg, MarketWatch
Last update: 8:10 p.m. EST Dec. 9, 2007Print E-mail RSS Disable Live Quotes

This column first was published in the weekend edition of The Wall Street Journal.

SAN DIEGO (MarketWatch) -- The reality of Generally Accepted Accounting Principles, or GAAP, is that they give companies just enough rope to hang themselves and their investors, if they so please. Much of GAAP is so subjective that you could drive side-by-side snow plows through the gray areas.

That is something to keep in mind if, with the latest wave of write-offs, you believe it is time to start bargain hunting among the most beaten-down financial-services companies tied to the mortgage blowup. The time may very well be right, but a recent report by Gradient Analytics warns that financial-reporting practices of some of these companies yesterday and today could still come back to bite investors tomorrow.

Gradient, a Scottsdale, Ariz., research firm that caters to mutual funds and hedge funds, was early to spot accounting issues at Krispy Kreme Doughnuts Inc. among others, and their stocks subsequently tumbled.

"I think for a number of years they played games," Donn Vickrey, a former accounting professor who co-founded and is now editor-in-chief of Gradient, says about the financial-services companies.

By "playing games" he means a tendency during the mortgage boom "to report numbers that were artificially high." There were a variety of ways to do that, all of them completely legitimate and blessed by the gods of financial accounting rules otherwise known as the Financial Accounting Standards Board.

One of the most-popular tactics was front-loading income and cash flows through what is known as "gain on sale" accounting, as loans were packaged and sold to other investors. The amount recognized largely reflected what the company expects to receive at some point in the future, based on predictions of such things as delinquencies, prepayments and interest rates. It is totally discretionary; the more conservative the predictions, the lower the gain.

Just as companies may have been reporting numbers that were too high, Vickrey believes some might now be reporting losses and charges that are artificially low, hoping they will somehow get bailed out before the situation worsens.

This is being done, he believes, by such things as deferring recognition of losses; transferring mortgages that are likely to default from one part of the balance sheet to another, where management has more discretion in determining the seriousness of the loss; somehow concealing "the aftereffects" of aggressive gain-on-sale accounting, and reliance on interest income from negatively amortized mortgages those in which the amount owed rises if payments don't cover all the interest due, which in this environment at best appears dicey.

Much of this, he says, involves meeting "the bare minimum letter of GAAP, but not adhering to the spirit of GAAP."

Among the five biggest companies involved in mortgage securities, Gradient believes Washington Mutual Inc. have been the most aggressive, with Washington Mutual edging out Countrywide as having "the most risk for a material misstatement." Washington Mutual didn't respond to requests for comment.

Countrywide said its accounting is appropriate and it has taken steps to reduce risk.

Gradient warns that Washington Mutual may not be properly valuing loans it is holding for investment purposes. As a result, reserves for future losses may be too low.

While the company boosted its loss provision in the third quarter, the Gradient report says "the increase appears to be too little too late as the allowance for loan losses has failed to keep pace with the increase in nonperforming loans."

Meanwhile, in recent years, interest from negatively amortized mortgages leapt as a percentage of interest income to 7.2% for the first nine months of this year from 1.8% in the same period two years ago. Not only is that income unsustainable, Gradient says, but more prone to write-offs, especially if there are increased delinquencies and defaults.

Then there's the high level of gain-on-sale income in prior years "that may signal additional risks to come."

Washington Mutual, the report says, ranked second behind only Countrywide in terms of its reliance on gain-on-sale. Countrywide has been on Gradient's screen for four years because of a variety of earnings-quality issues.

As with Washington Mutual, Gradient now wonders whether there could be "hidden losses" among loans held by Countrywide for investment. While reserves as a percentage of nonperforming loans have been rising, hitting 63.4% as of Sept. 30, Gradient says they still lag behind peers, including Washington Mutual. Countrywide disagrees, and says that "when all of the relevant factors are considered, our 'reserves' are comparable to our competitors."

Like Washington Mutual, Gradient says Countrywide suffers from "low quality income" related to negative-amortized loans. "Unfortunately," the report says, in trying to determine its exposure, "Countrywide does not provide as much detail as other firms we surveyed."

While the stocks of these companies and others have fallen considerably, Vickrey believes "a lot remains to be revealed." Can't wait.

Herb Greenberg is senior columnist for MarketWatch and contributor to CNBC television based in San Diego.

U.S. Mortgage Delinquencies Rise to 20-Year High (Update1)

By Kathleen M. Howley

Dec. 6 (Bloomberg) -- The number of Americans who fell behind on their mortgage payments rose to a 20-year high in the third quarter as borrowers were unable to refinance or sell their homes.

The share of all home loans with payments more than 30 days late, including prime and fixed-rate loans, rose to a seasonally adjusted 5.59 percent, the highest since 1986, the Mortgage Bankers Association said in a report today. New foreclosures hit an all-time high for a second consecutive quarter.

The surge in foreclosures is expanding the inventory of unsold homes and contributing to the decline in home prices. The National Association of Realtors is forecasting new home sales will drop 13 percent in 2008. About 40 percent of lenders have increased their standards for the most creditworthy borrowers to qualify for a so-called prime loan, according to a Federal Reserve study in October.

``These are the first numbers we've seen that combine the meltdown of the credit markets with the drop in home prices,'' said Jay Brinkmann, vice president of research and economics for the Washington-based bankers trade group.

President George W. Bush and U.S. Treasury Secretary Henry Paulson plan to announce a proposal today to freeze some subprime mortgages to stop a wave of foreclosures that has cut prices and demand for houses.

California, Florida Lead

One in every five adjustable-rate subprime loans had late payments in the quarter, a number that excludes the one of every 10 already in foreclosure, the trade group said. Foreclosures started on all types of mortgages rose to an all-time high of 0.78 percent from 0.65 percent.

In the quarter, 3.12 percent of prime borrowers made their mortgage payments at least 30 days late, up from 2.73 percent in the second quarter, the report said. The subprime share of late payments rose to 16.3 percent from 14.8 percent.

The numbers were driven by California, the U.S.'s largest state, and Florida, Brinkmann said. The two states had 36.4 percent of all of the nation's prime adjustable-rate loans and had 42.4 percent of new foreclosures during the quarter, he said. They had 28.1 percent of subprime adjustable mortgages and 33.7 percent of foreclosure starts for that type of loan.

That is more than double the 15 percent who reported boosting requirements in July, the prior survey. Sixty percent of banks said they tightened qualifications for so-called non- traditional mortgages such as interest-only loans, the Fed said.

The Mortgage Bankers report is based on a survey of 45.4 million loans by mortgage companies, commercial banks, thrifts, credit unions and other financial institutions.

To contact the reporter on this story: Kathleen M. Howley in Boston at kmhowley@bloomberg.net .

Last Updated: December 6, 2007 10:31 EST

US property risks

Published: December 2 2007 19:28 | Last updated: December 2 2007 19:28

The subprime residential lending crash has dealt the market a body blow. But its aftershocks could hit lenders with a second real estate-related punch, if the highly leveraged commercial property market succumbs to the contagion.

Banks have significantly tightened their lending standards this year, and commercial real estate has felt the effects particularly quickly. Commercial mortgage-backed security issues, which finance about half of deals and were a key driver of the recent market boom, dropped 84 per cent in October from a record high of $38.5bn in March. At one point, some loans actually exceeded property values. Now, typical loan-to-value ratios have retreated to about 70 per cent – when deals are completed at all.

Lenders have, appropriately, returned to their senses. But some may have changed from partygoer to policeman too late. Tough new standards will not reduce risk on ambitious past financings. US banks could see $11bn to $78bn of commercial real estate losses if the lending crisis spreads, according to Goldman Sachs. Each lender’s risk would depend on its mix of whole loans and CMBS, as well as newer, riskier commercial real estate collateralised debt obligations and even riskier B-note or mezzanine debt. Those more speculative lending markets were bursting at the seams with demand this year. But they have never been tested by a serious downturn.

The commercial property sector is not likely to suffer the huge falls experienced by the worst-hit residential markets – prices are more likely to correct by, say, 10 per cent to 15 per cent. Supply is near its tightest point in decades. And though total US real estate debt has skyrocketed to $14,000bn, commercial leverage has expanded far more slowly than residential debt.

But certain factors facing commercial tenants compound the threat. Store, hotel and factory owners are holding their breath as the economy struggles under the weight of the housing crisis. Even the hot Manhattan office market has seen almost 10,000 Wall Street lay-offs this year. Given banks’ astronomical losses in subprime lending, a modest slide in commercial property values may be the best they can hope for.

Copyright The Financial Times Limited 2007