NEWS: Betting Against the House

AHEAD OF THE TAPE
By JUSTIN LAHART

Wall Street Journal
May 24, 2005; Page C1

On Friday, Federal Reserve Chairman Alan Greenspan said that, although there are some signs of "froth" in the housing market with "a lot of local bubbles," the Fed doesn't see a bubble nationally. To many ears, that would seem like a moderate assessment.

News reports professing a housing bubble have become so frequent that James Bianco, head of investment-research firm Bianco Research, lists them in a section of his email to clients, dubbed "Your Daily Installment of 'Picking a Top in the Real Estate Bubble.' " Yesterday there were seven articles listed.

As for his take, Mr. Bianco thinks that bubbles don't end when everybody is screaming about how there is a bubble; the bubble pops when everybody has concluded that what has gone on with prices make sense.

In an online WSJ.com poll last week, 81% of respondents said they thought the U.S. housing market was in a bubble. Most of the people who responded "yes" thought the bubble would keep growing.

Such thinking can be dangerous, because often there isn't much of a step between believing that a bubble will continue and believing that not participating in the bubble will amount to lost opportunity. The late economic historian Charles Kindleberger pointed to Isaac Newton, who, convinced that price speculation in the South Sea Company had run too far amuck, sold off his shares for a profit in the spring of 1720. But he bought at higher prices later in the year, and suffered for it.

For those who would speculate in real estate, today's report on existing-home sales from the National Association of Realtors isn't likely to act as a deterrent. On average, economists expect an annualized 6.9 million homes came off the block in April, up from March's 6.89 million. Meantime, long-term interest rates have been falling -- yesterday the yield on the 10-year Treasury slipped to a three-month low of 4.07% -- giving would-be speculators the wherewithal to buy.

In the end, whether the housing boom is a bubble may matter less than the fact that the U.S. economy has become highly geared toward the real-estate market. Northern Trust economist Asha Bangalore points out that employment in housing and housing-related industries has accounted for 43% of the rise in private-sector payrolls since late 2001. If housing cools, what will take up the slack?

New Mortgage Guidelines Planned

Regulators Fear Growth
In Offerings May Raise
Risk to Borrowers, Lenders

By RUTH SIMON and JAMES R. HAGERTY
Staff Reporters of THE WALL STREET JOURNAL
May 19, 2005; Page D2

Federal banking regulators, concerned about growing risks in the mortgage market, are planning to issue new guidelines for mortgage lenders.

The new guidelines, which could be completed as soon as early next year, come at a time of growing concern that the proliferation of new mortgage products could mean higher risks to borrowers and lenders. Regulators are turning their attention to mortgages after issuing their first-ever guidelines for credit-risk management for home-equity lending this week, warning financial institutions to re-examine their loan criteria.

FURTHER READING • Concerns Mount About Mortgage Risks1 05/17/05

"Our next challenge is to look at what our expectations are for first mortgages," says Barbara Grunkemeyer, deputy comptroller for credit risk at the Office of the Comptroller of the Currency, which is taking the lead on this issue. "There's a consensus among regulators that we need to be working on this."

Worries about risks in the mortgage market have been heightened by the growing popularity of adjustable-rate mortgages and more novel lending products such as interest-only mortgages, loans for which borrowers provide little or no documentation of their financial resources, and loans that can result in negative amortization, or a rising loan balance. Interest-only loans accounted for 17% of originations in the second half of 2004, according to the Mortgage Bankers Association. Adjustable-rate mortgages, not including interest-only ARMs, accounted for an additional 46% of originations. The MBA figures reflect dollars lent, not the actual number of mortgages.

TAKING A CLOSER LOOK Here are some of the mortgage products on regulators' radar screen: • Interest-only mortgages: Borrowers can pay interest and no principal in the loans' early years. • Low- or no-documentation loans: Borrowers provide less than full or no verification of income and assets. • Option ARMs: Borrowers have multiple payment choices; electing the minimum payment can result in a rising loan balance.

The MBA survey also found that 8% of mortgage originations were so-called Alt-A loans, which are typically made to borrowers who have good credit but don't necessarily fit traditional lending standards. More than two-thirds of Alt-A mortgages are made with less than full or no documentation of income and assets, according to UBS AG.

Interest-only loans allow the borrower to pay only the interest due during an initial period, typically five years or so. After that, the borrower must begin paying off the principal, resulting in a sudden jump in the monthly payments. With an adjustable-rate, interest-only mortgage, the onset of principal payments could coincide with a rise in the interest rate, creating a double payment shock.

Many of these loans are especially popular in high-cost markets. In California, interest-only loans accounted for 61% of the mortgages taken out to buy homes in the first two months of this year, up from 47% in 2004 and less than 2% in 2002, according to LoanPerformance, a unit of First American Corp. Option ARMs, which can result in negative amortization, accounted for nearly one-third of jumbo mortgages -- currently loans above $359,650 -- in the fourth quarter of 2004, up from roughly 6% in the first quarter of that year, according to UBS.

These loan programs can provide benefits to borrowers and lenders, but many are relatively new or are being used more broadly than ever before.

In addressing the rapidly growing home-equity market, banking regulators said they were concerned about looser underwriting standards. Problems with home-equity loans can be particularly troublesome for lenders, regulators say, because the home-equity lender is second, behind the provider of the first mortgage, if a borrower can't make payments.

Risk factors identified in the home-equity guidelines include interest-only payments, limited or no documentation of borrowers' assets, and higher loan-to-value and debt-to-income ratios. "We're very mindful that many of the things we see in home equity are also prevalent in first mortgages," Ms. Grunkemeyer says.

Regulators are also likely to address the risks to both borrowers and lenders posed by the increasing popularity of adjustable-rate mortgages. "Borrowers are going for the ARMs because they can qualify for a slightly bigger mortgage," she adds. "There are a lot of issues to be addressed there."

Regulators say they have just begun discussing the risks in the mortgage market and have yet to take pen to paper. Before issuing any guidance, they expect to consult with Fannie Mae and Freddie Mac, which, as the biggest buyers of mortgage loans from lenders, effectively set many standards in the industry.

Tom Lund, Fannie Mae's interim head of the department that buys loans for single-family homes, said interest-only loans and other newer types of credit being offered by lenders make sense for some borrowers. But, he says, lenders should be concerned if these loans are being used by people who are hard-pressed to meet their monthly payments. "In many cases the consumers may not understand all the risks," Mr. Lund adds. Since late last year, he says, Fannie has tightened its criteria for buying certain types of loans.

NEWS: Fed Worries About Housing Bubble

CAPITAL

By DAVID WESSEL

The Fed Starts to Show Concern

At Signs of a Bubble in Housing

May 19, 2005; Page A1

In the debate over whether the housing market is a bubble about to burst, the crowd that argues it isn't has been able to cite reassuring utterances by Federal Reserve officials. But there are proliferating signs that the housing market is looking a bit frothy. And now the U.S. central bank is beginning to worry more about it.

It isn't only that housing prices keep rising faster than almost anything else, up 10% on average nationally in 2004, according to the U.S. Office of Federal Housing Enterprise Oversight, and up 25% or more in the hottest markets in California, Florida and Nevada.

It isn't only that the clever mortgage industry keeps coming up with new ways to lend people money to buy houses that involve ever-more leverage and little -- or sometimes no -- down payment.

It's that more people are buying second and even third homes, expecting that prices will continue to rise so they can sell the houses quickly at a profit -- and that is drawing the Fed's attention. The National Association of Realtors says its surveys find that 23% of all homes purchased in 2004 were for investment, and a further 13% were vacation homes. It's as if Americans got tired of the stock market, and decided to look elsewhere to try to lose money.

For a long time, Federal Reserve Chairman Alan Greenspan dismissed suggestions that the U.S. was in the early stages of a housing bubble. He talked about the extraordinary demand for houses among hard-working immigrants. He emphasized that housing, unlike stocks, is a local market, so it's almost impossible to have a national housing bubble. He explained that it's hard to speculate in a house that you own because to sell it you have to move out.

But there has been a little more concern creeping into his commentary in the past few months. "We do have characteristics of bubbles in certain areas, but not, as best I can judge, nationwide," he told a House committee in February. Mr. Greenspan speaks to the Economic Club of New York at lunchtime tomorrow. If housing comes up in his remarks or if he is questioned on the subject by one of the prominent economists there, look for the Fed chairman to mention -- as Fed Governor Donald Kohn did recently -- the upturn in people buying vacation homes, second homes or other homes on the risky bet that housing prices will continue to rise as they have lately.

Mr. Greenspan hasn't yet hit the "irrational exuberance" gong, the phrase he used to warn about the stock market in December 1996. The Fed and other bank regulators, however, this week warned banks to take more care with home-equity loans, noting that such loans are "subject to increased risk if interest rates rise and home values decline." (Did you say decline? Gulp.) Even a slowing of the pace of increase in housing prices probably would dent consumer spending, which, for the past couple of years, has been helped by Americans tapping their home equity.

Other Fed officials have begun to express some anxiety. In a speech last month, Mr. Kohn said, "A couple of years ago I was fairly confident that the rise in real-estate prices primarily reflected low interest rates, good growth in disposable income and favorable demographics." Mr. Kohn was a longtime adviser to Mr. Greenspan before his appointment to the Fed board.

No longer. "Prices have gone up far enough since then relative to interest rates, rents and incomes to raise questions; recent reports from professionals in the housing market suggest an increasing volume of transactions by investors, who...may be expecting the recent trend of price increases to continue," Mr. Kohn said.

A surge in the number of people buying houses as a speculative investment is the contemporary equivalent of the story about Joseph P. Kennedy, father of the late president. According to the tale, he sold his stocks a week before the 1929 crash because he heard a shoeshine boy named Billy touting U.S. Steel and RCA. When the shoeshine boy starts giving you tips, he is supposed to have said, it's time to get out of the market.

The Fed, which contributed to the housing boom by keeping short-term interest rates so low for so long -- and encouraging the bond market to do the same with the long-term rates that determine mortgage rates -- doesn't expect a collapse of housing prices or an economic calamity. Mr. Kohn's worst case is "an erosion of real house prices" -- translation: an increase in house prices that falls short of the overall inflation rate -- "rather than a sudden crash."

Americans who have owned their homes for the past few years have a lot of equity in their homes: $9.62 trillion worth at the end of last year, up 13% from a year earlier, according to the Fed's tally. Even if house prices fall a bit, homeowners still will have significant equity -- except for those who have hocked nearly all the increase in home values with frequent refinancing or large home-equity loans.

But if house prices stop climbing, it won't be pleasant. Americans will feel poorer -- and they'll spend less as a result.

NEWS: Mortgage Risks

Concerns Mount
About Mortgage Risks

Latest Data Show Move Toward
Alternative Loans Is More Pronounced
Than Previously Thought

By RUTH SIMON
Staff Reporter of THE WALL STREET JOURNAL
May 17, 2005; Page D1

In the latest sign of how frothy the housing market has become, new data show the degree to which people are stretching to buy homes in a hot housing market.

The data, from the Mortgage Bankers Association, show that adjustable-rate and interest-only mortgages accounted for nearly two-thirds of mortgage originations in the second half of last year. Both types of loans have helped fuel the strong housing market since they carry lower initial monthly payments than do fixed-rate loans, enabling borrowers to purchase more-expensive homes.

…

Though it has been clear that borrowers in high-priced markets have been gravitating to products that make homes more affordable, the shift has been greater than expected. In California, where home-price growth has been sizzling, interest-only loans accounted for 61% of the mortgages taken out to buy homes in the first two months of this year, up from 47.1% in 2004 and less than 2% in 2002, according to an analysis prepared for The Wall Street Journal by San Francisco researchers LoanPerformance, a unit of First American Corp. Just 18% of California households can afford to buy a median-price house using a conventional 30-year fixed-rate mortgage, according to a report issued this month by the California Association of Realtors.

…

The Mortgage Bankers Association conducted the survey of the interest-only and ARM share of mortgage originations in an effort to provide more accurate information about the housing market. The group's survey found that interest-only mortgages accounted for 17% of loans originated in the second half of 2004. And 46% of loans were adjustable-rate loans that don't carry an interest-only feature. The data reflect dollars lent, not the number of mortgages.

…

The MBA's weekly surveys -- which look only at application volume, not loans that are actually made -- had put the share of ARMs, including interest-only loans, at roughly 40% to 50% this year. That is up from as little as 18% of application volume in early 2003.

…

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NEWS: U.S. Warns Lenders To Elevate Standards

By Kirstin Downey
Washington Post Staff Writer
Tuesday, May 17, 2005; A01

Federal banking regulators yesterday warned banks and other lenders to be more selective about who can get home equity loans and lines of credit because rising interest rates may make it harder for people to repay their loans.

Government officials said that while mortgage defaults remain rare, many institutions are loading up on high-risk loans.

They urged lenders to review interest-only loans, which allow borrowers to delay principal payments for years, and "no-doc" loans, which don't require documenting borrowers' assets and income. They also suggested that lenders that refuse to do so may find themselves facing heightened federal oversight.

...

The regulators' warning came in what is called a "guidance" to the lending institutions, issued jointly by the Office of the Comptroller of the Currency, the Federal Reserve, the Federal Deposit Insurance Corp., the Office of Thrift Supervision and the National Credit Union Administration. They told the lenders they regulate that the institutions' "credit risk management practices have not kept pace with the products' rapid growth and easing of underwriting standards."

...

The regulators urged banks, thrifts and credit unions to use particular caution in making loans originated by mortgage brokers, who are not bank employees and who are paid by commission based on the volume of loans they complete.

"For control purposes, the financial institutions should retain appropriate oversight of all critical loan-processing activities, such as verification of income and employment and independence in the appraisal and evaluation function," the guidance said.

Similarly, lenders were also warned to be wary of loans purchased from financial institutions called "correspondents," which make loans on their own for resale to other lenders. Banking regulators noted that correspondents, too, "have an incentive to produce and close as many loans as possible."

Meanwhile, lending institutions should be monitoring the financial health of their home equity customers by periodically checking their credit scores, assessing the way people use their loans, monitoring home values in the neighborhood and using behavioral scoring to identify potential problem accounts. When such problems arise, lenders should refuse to extend additional credit or even reduce the credit limit available, the agencies said.
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