NEWS: Housing-Bubble Talk Doesn't Scare Off Foreigners

Global Investors Gobble Up Mortgage-Backed Securities, Keeping Prices Strong

By RUTH SIMON, JAMES R. HAGERTY and JAMES T. AREDDY

Staff Reporters of THE WALL STREET JOURNAL

August 24, 2005; Page A1

Strong demand for mortgage-backed securities from investors world-wide is allowing American lenders to make more loans -- and riskier ones -- in a way that is helping prolong the boom in U.S. house prices.

The cash pouring in -- not only from U.S. investors but increasingly from Europe and Asia -- keeps stoking the housing market even as the Federal Reserve Board continues to raise interest rates, normally something that damps home prices. The market has shown a few signs of slowing recently, and talk of a bubble has grown louder, but prices continue to rise or remain at lofty levels as investors continue to gobble up mortgage-backed securities and banks keep lending.

"As the Fed has tightened, lenders have eased" terms for borrowers, says Mark Zandi, chief economist at Economy.com, a forecasting firm in West Chester, Pa.

Investment banks and other firms have been buying mortgage loans from lenders and packaging them into securities for sale to investors since the 1980s. But investor demand has surged in recent years, largely because in an era of low returns, mortgage-backed securities offer yield-starved investors much higher returns than government bonds.

U.S. lenders will make about $2.8 trillion in home-mortgage loans this year, according to the Mortgage Bankers Association. The MBA estimates that about 80% of these loans will end up in mortgage-backed securities. Mortgage-backed securities outstanding at the end of the first quarter totaled $4.61 trillion, up 61% since the end of 2000. In the same period, total Treasury securities outstanding grew 35% to $4.54 trillion.

[riskier loans graphic]

Investors' strong demand for mortgage debt, besides allowing lenders to offer many borrowers better terms, has also made it easier to offer mortgages to borrowers who might not easily qualify for a loan. The growth of the mortgage markets spreads the risks around. But some mortgage-industry analysts say lenders have become less stringent in their loan terms because they can sell almost any type of loan to those who package mortgage securities for investors.

"Loose lending standards are probably the single biggest thing fueling the speculative fever we have today" in housing, says Kenneth Rosen, an economist who is chairman of the Fisher Center for Real Estate at the University of California at Berkeley.

In a world of low interest rates, the market for mortgage securities is simply too big and profitable for many investors to ignore. Investors can earn about 5.5% on mortgage securities whose payments are guaranteed by Fannie Mae or Freddie Mac, government-sponsored companies. Those who can stomach greater risk can buy subprime mortgage securities, which come with no guarantee but can yield as much as 15%, according to Bear Stearns. By contrast, 10-year U.S. Treasurys yield about 4.2%; the equivalent government securities in Germany yield about 3.2% and in Japan 1.5%.

The buyers of mortgage-backed securities include U.S. pension funds, hedge funds and insurance companies. But overseas investors are the fastest-growing source of demand. The trade publication Inside MBS & ABS estimates that foreigners held $280 billion of U.S. mortgage securities at the end of 2004, or 6% of the total outstanding. The foreigners' holdings rose 26% last year and have continued to bound ahead so far this year, Inside MBS & ABS says.

"There's this insatiable appetite for mortgage-backed securities world-wide," says Andrew Sciandra, a senior vice president at IndyMac Bancorp, a California thrift, who heads a team that creates those securities. In the past year, Mr. Sciandra has met with investors from places like Germany, France and Abu Dhabi. Asian investors now account for roughly 10% to 20% of mortgage securities sold by IndyMac.

For homeowners, the growing international demand for mortgages means it's increasingly likely that the money they borrow to buy a home or refinance their mortgage is coming ultimately from outside the U.S. When Claude Gaty, a chef and co-owner of a bistro in Las Vegas, recently refinanced the mortgage on his four-bedroom Las Vegas home, the lender was IndyMac. But the bulk of the money came from investors in Asia.

IndyMac pooled Mr. Gaty's loan with about 3,000 other mortgages that carry a fixed rate for the first three, five or seven years. Mr. Gaty is paying both principal and interest on his loan, but most of the loans in the pool are interest-only mortgages, which allow borrowers to pay no principal in the early years. When the $650 million offering of triple-A rated bonds backed by these mortgages came to market in June, it drew more than a dozen investors from Europe, Asia and the U.S., according to Deutsche Bank, which handled the deal. Such bonds typically yield 0.75 to 1.15 percentage point more than Treasurys, Deutsche Bank says.

The most recent entrant to the market is China. Its banks are rich with deposits from Chinese companies that earn dollars exporting to the U.S. Dollars have also been handed to some banks by the government in Beijing as part of its efforts to strengthen their balance sheets.

Until a few years ago, Chinese investors restricted U.S. investment mostly to Treasurys. Now, to boost their yields and because they consider the market safe, bankers from a number of institutions say they are devoting more of their portfolios to mortgage securities. Some bankers say their goal is to have 40% of their U.S. dollars in asset-backed securities.

China's government also is testing U.S. mortgage investment. The country's Bank of Communications, the only bank with a mandate to help manage China's $700 billion of foreign-exchange reserves, has recently put a sliver of those reserves into mortgage-backed issues, according to a banker there. The State Administration of Foreign Exchange, the government agency in charge of the reserves, declined to comment.

Zhu Kai, who helps manage U.S. dollar investments at Bank of China, says in a rare interview that his mortgage-backed portfolio has "plenty of room to grow." Mr. Zhu expresses confidence in the U.S. dollar and the health of the U.S. home market. Housing is so vital to the U.S. economy, Mr. Zhu and some of his counterparts at other Chinese banks reason, that U.S. authorities will prevent a bust.

Even the recent decision by the Chinese government to raise the value of its currency by about 2% isn't likely to lead Chinese banks to shift their plans. "The timing may be a little bit surprising but we will not change our investment portfolio," Mr. Zhu says.

While Asian investors have largely focused on triple-A-rated bonds, other investors are buying lower-rated debt. These bonds, which are created when bankers carve up pools of mortgages, offer higher yields, but also bear the first risk of losses should borrowers default. Investors who buy these bonds in effect set the standards for which mortgages are made by deciding how much extra yield they need to compensate for the added risks of lower-quality loans. They include real-estate investment trusts, hedge funds and investors from Europe.

Strong investor interest has also made loans available to borrowers with poor credit and many other people who might otherwise have trouble getting a mortgage. Subprime loans included in mortgage securities totaled $401.5 billion last year, nearly double the total for 2003, according to Standard & Poor's. Meanwhile, loans with less than full documentation of the borrower's income and assets accounted for 70% of mortgage securities rated by Standard & Poor's in this year's first half, double the level recorded in 2000.

"There's no question that [lending] standards have loosened over the past couple of years," says Arthur Frank, director of mortgage research at Nomura Securities International in New York. If house prices fall, "you may well have some pretty serious credit problems," hurting holders of the lower-rated mortgage securities.

Mr. Zhu, the Chinese fund manager, is sanguine, for now. The U.S. housing market is "maybe losing a bit of steam," Mr. Zhu says. "I think the monetary authorities, they don't want this housing market to burst. I don't think it is a bubble. But if things go on like this for another five years, it's a different story."

NEWS: Bankers' Group Issues A Caution on Home Loans

By JAMES R. HAGERTY

Staff Reporter of THE WALL STREET JOURNAL

August 24, 2005; Page D3

The Mortgage Bankers Association, whose members have been promoting home loans with low initial repayments, urged consumers to choose such loans with care.

"Borrowers need to be vigilant to be sure that they are prudently measuring and managing" the added risks many accept by embracing loans that minimize monthly payments in the early years but can require much-higher payments later, the trade group said in a 30-page report released yesterday.

The report comes in the wake of recent warnings from Federal Reserve Chairman Alan Greenspan, bank regulators and the National Association of Realtors about the risks of such loans.

The mortgages in question include interest-only loans with rates that adjust periodically based on prevailing rates. With these loans, borrowers pay only the interest due during an initial period, often five years. Monthly payments then rise steeply as the borrower begins paying off the principal. Borrowers could face a double payment shock if the onset of principal payments coincides with a rise in interest rates.

Critics also have raised questions about the risks of "payment-option" loans. These loans give borrowers several payment options each month, including one that falls short of the interest due. When borrowers select that option, their loan balances increase -- something known among mortgage bankers as "negative amortization."

These loans are especially popular in California and other places where home prices are surging. The mortgage bankers' report said that these "innovative" mortgages help more people become homeowners. Still, the rising popularity of interest-only and payment-option loans exposes borrowers to "potentially substantial payment shocks," the report said.

Mitigating those risks, the report said, is an improving job market, which means more consumers will be able to afford higher loan payments. In addition, the report said, "there is only a small percentage of borrowers that are potentially vulnerable to an increase in [interest] rates or other economic shock." The report cited a Census Bureau survey showing that 35% of homeowners don't have any mortgage debt and an additional 50% have fixed-rate loans.

Competition among lenders, however, has spurred some of them to take more risks. Ameriquest Mortgage Co., Orange, Calif., one of the nation's largest home lenders, until last year avoided offering interest-only loans to subprime borrowers, those with blemished credit histories.

Spurred by rivals who were using interest-only loans to gain market share, however, Ameriquest began offering them to some subprime borrowers earlier this year. "We take what we consider a prudent approach to serve the interests of both our borrowers and our investors," an Ameriquest spokesman said. "We restrict interest-only loans to owner-occupied properties and require our interest-only borrowers to have higher credit scores."

Investors Fret Mortgage Balloons Will Burst

By JESSE EISINGER
July 27, 2005; Page C1

There has been plenty of talk about a housing bubble, but very little about a mortgage bubble.

Now investors are starting to see worrisome signs in some banks' latest quarterly earnings reports. In others, such signs are absent. Good news? Nope, because disclosure is so poor at so many banks.

As home prices have soared, banks have been enticing customers with sweet-sounding mortgages that lower monthly payments, including interest-only loans. The most dangerous development is mortgages that offer payment options.

Typically, these so-called option adjustable-rate mortgages, or option ARMs, let customers choose how much to pay each month. They can make the standard principal-and-interest payment or pay just the interest. And then there's the even dicier option to make just a low minimum payment, as with a credit-card bill.

Hey, when there are Escalades to buy and home prices are always rising, you really have to learn to stop worrying and love that minimum payment. The catch is that the unpaid portion of the interest gets tacked onto the principal -- a "negative amortization" that increases the size of the mortgage. Left with more debt, the customer is more vulnerable to rising rates.

These products are advertised in misleading ways. Banks pitch that customers can pay back the loan at a rate of, say, 1%. But that's just the rate used to calculate the minimum payment in the first year, not the actual underlying rate. The rising popularity of option ARMs concerns some prudent banking executives, including Golden West Financial's Herb Sandler, who runs the midsize bank with his wife and sells plenty of the mortgages. Some lenders "are clearly faking their borrowers out," he says.

Along with Golden West, publicly traded lenders with big exposure to these products include Countrywide and Washington Mutual and smaller California banks such as Downey, First Fed and Indymac. Golden West has been selling them for 25 years and has a solid track record with them, even in recessions and rising-rate environments. When fully explained to the right customers, such as a Porsche salesman who makes plenty each year but doesn't know how much he'll score from month to month, "it's a terrific borrower loan," says Mr. Sandler. "We have never had a delinquency, much less a foreclosure, due to the structure of the loan."

But some banks are lowering their credit standards, sometimes qualifying borrowers based on their ability to make the minimum nut, not whether they can afford the whole deal. "That is an outrage," Mr. Sandler says.

Option ARMs are wonderful not just for borrowers who can't afford their houses, but also for investors who look only superficially at a bank's earnings report. A bank books the entire amount that a customer owes as income each month, not the minimum payment that's actually paid. Voilà, noncash earnings.

It gets better: The unpaid interest gets tacked on to the bank's outstanding loan total, allowing the bank to display loan growth, which investors love. "You get earnings and growth. What more can you ask for?" says Keefe, Bruyette & Woods analyst Fred Cannon.

But there could be credit problems down the road. And at some point, it's plausible regulators might fret about the bank's capital.

Last week, Golden West's stock took a hit after it disclosed how much its exposure to option ARMs has increased. The company reported that $160.2 million of its loans was actually unpaid interest tacked on to borrowers' principal -- that negative amortization I mentioned. That's a huge leap from last quarter's $90.2 million and $27 million in last year's second quarter.

The company reassures investors that the total is a mere 0.14% of its loans. But as a percentage of net interest income, the $70 million change in the negative amortization figure was 10% in the second quarter, compared with 5% in the first quarter and practically nothing a year ago, says Mr. Cannon.

Mr. Sandler says Golden West's lending practices are disciplined, so it won't get into trouble. The only risk, he concedes, is that home prices decline broadly, in which case all mortgages suffer, regardless of structure.

But good companies are often undermined by the irrational practices of competitors. It's not quite fair of me to pick on Golden West. I do so only because it fully discloses its exposure.

Other major banks are more reticent. Washington Mutual disclosed some aspects of its exposure for the first time this quarter, but left questions unanswered, says Mark Agah, analyst for independent research firm Portales Partners. It originated $19.6 billion of option ARMs in the second quarter, or 37% of its home-loan volume. WaMu didn't report the total amount of deferred interest beefing up its loan totals. Instead, it said option ARM borrowers' principal had grown by $26 million, or 0.04% of outstanding balances. That doesn't count all the deferred interest from borrowers who paid down their principal for a time but then started making minimum payments. Washington Mutual actively sells most of its option ARMs into the secondary market, but that market might not always be available on attractive terms.

A WaMu spokeswoman says in an email that the company is considering how best to disclose option ARM data.

Countrywide discloses even less. It says its second-quarter ARM volume was $67 billion, or 56% of its home-loan volume. But the company didn't disclose the percentage of option ARMs in its financial statements and doesn't disclose the amount of negative amortization. In response to questions from investors during its earning conference call yesterday, the bank said that 20% of its loan production this year has been option ARMs, at least 50% from California. Countrywide said on the call that it, too, planned to increase disclosure.

What should investors do? Problems won't come today or tomorrow, but don't look now: Rates, they are arisin', and that's when some borrowers will run out of options. At least investors still have some options left. Like reducing their exposure to mortgage banks.

NEWS: Mortgage Lenders Loosen Standards

Mortgage Lenders Loosen Standards
Despite Growing Concerns, Banks Keep Relaxing Credit-Score, Income and Debt-Load Rules

By RUTH SIMON

Staff Reporter of THE WALL STREET JOURNAL

July 26, 2005; Page D1

Mortgage lenders are continuing to loosen their standards, despite growing fears that relaxed lending practices could increase risks for borrowers and lenders in overheated housing markets.

Novel loan products have helped fuel much of the run-up, which continues to defy expectations, as reflected in home-sales data released yesterday. Existing-home sales hit another record in June, up 2.7% from May's heated levels, according to the National Association of Realtors. Median home prices rose 14.7% from June 2004.

But lenders are making it still easier for borrowers to qualify for a loan. They are lowering the credit scores needed to qualify for certain loans, increasing the debt loads borrowers can carry and easing the way for borrowers to get loans while providing little documentation. In some cases, lenders are easing standards not only for homeowners, but also for the growing number of people buying residential real estate as an investment.

In one recent move, Chase Home Finance, a unit of J.P. Morgan Chase & Co., this spring began allowing some of its customers to take out home-equity loans and lines of credit without having their incomes verified. Under the new program, income verification isn't required for home-equity loans of up to $200,000, provided that the borrower's total mortgage debt doesn't exceed 90% of the property's value or $1.5 million. The change "is not for all customers -- it's only for customers with the very highest credit rating," a company spokeswoman says. Loans with little or no documentation have grown in popularity industry-wide.

Last month, Wells Fargo & Co. began allowing buyers of investment properties in some parts of the country to take out interest-only mortgages, which let borrowers pay interest and no principal in the loan's early years. Another recent change in some markets boosts the standard for how much total debt and housing expenses certain borrowers can carry to 45% of their income from 38%.

A Wells Fargo spokesman says the company doesn't discuss specific changes, but that it consistently monitors economic conditions in its major markets and will at times "modify our lending guidelines in a specific market." He added, "On a national basis, we have made no substantive changes to our lending policies and practices."

Banking regulators, meanwhile, are paying closer attention to mortgage lending practices. "Lending standards are continuing to ease," says Barbara Grunkemeyer, deputy comptroller for credit risk at the Office of the Comptroller of the Currency, which is putting the finishing touches on its annual survey of bank underwriting standards. Federal Reserve surveys of bank loan officers show that lenders have tended to loosen standards since early 2004, following a period of relative tightening.

In some cases, lenders have tweaked their offerings by reducing the minimum credit scores needed to qualify for certain loans. Countrywide Financial Corp., for instance, recently cut by 20 points the minimum credit score borrowers with bigger loan amounts need to qualify for one of its popular loan programs. A Countrywide spokeswoman says the change was designed to make the terms of this loan consistent with its other offers.

The continuing loosening of lending standards has helped push the homeownership rate to a record 69% of U.S. households. Mortgage delinquencies, meanwhile, have remained low, with just 1.08% of residential mortgages in foreclosure proceedings at the end of the first quarter, down from 1.17% five years earlier, according to the Mortgage Bankers Association. Low interest rates and rising home prices have helped keep delinquencies down by keeping monthly payments in check and making it easy for borrowers who run into trouble to refinance or sell their homes at a profit.

But the lowering of standards has also raised concerns that some borrowers may run into trouble making their payments, and that defaults could rise. In May, in response to concerns about looser underwriting standards, bank regulators issued their first-ever guidelines for credit-risk management for home-equity lending. Regulators are working on new guidelines for mortgage lenders.

In addition, bank examiners "are looking more at how banks originate first mortgages today than they were a year ago," says Ms. Grunkemeyer of the Office of the Comptroller of the Currency. "The reason they are doing it is because the mortgage products [lenders] are originating are higher risk."

Washington Mutual Inc. says it's loosening its guidelines on some products while tightening them on others. In June, it began offering home-equity lines of credit to borrowers who buy condominium units as an investment or as a second home. Another recent change lets borrowers who buy a second home or investment property finance as much as 90% of the home's value, up from 75%. Sales of investment properties have surged recently, adding fuel to the heated housing market.

The Seattle-based lender says it has also moved to toughen some standards. Earlier this year, Washington Mutual began setting stricter limits on the size and loan-to-value ratios for loans above $7 million. It is also reassessing its credit standards for investment properties and second homes, says Jim Vanasek, the company's chief enterprise risk-management officer.

"There's been a growing awareness over the past six to nine months that the risks are starting to increase with the very, very rapid price escalation we have seen," Mr. Vanasek says. "I would be surprised if mortgage lenders don't do some degree of reining in or tightening over the next several months."

So far, evidence of tightening has been hard to detect. "The trend toward relaxing standards is still relatively strong," says Gibran Nicholas, a mortgage broker in Ann Arbor, Mich. Mr. Nicholas expects this pattern to continue as long as foreclosure rates remain low and demand remains high from investors who buy bonds backed by pools of mortgages.

Some lenders say they are being forced to relax their standards to remain competitive. U.S. Bank Home Mortgage, a unit of U.S. Bancorp, says interest-only mortgages and loans with less-than-full documentation now account for about 10% of its business, up from just 4% a year ago.

"We're just offering the product that a lot of our competitors have offered," says U.S. Bank President Dan Arrigoni. "If anything, we have to think about loosening them if we want to compete." But, he says, U.S. Bank has resisted pressures to offer increasingly popular option adjustable-rate mortgages -- which carry starting rates as low as 1% and give borrowers multiple payment choices -- because the bank considers them too risky.

Lenders also say that advances in technology and data analysis enable them to do a better job of determining who is a good credit risk. "One of the things that is often missed is that we've become much better predictors of loan performance with automated underwriting systems and appraisal practices," says Jerry Baker, president and chief executive of First Horizon Home Loan Corp., a unit of First Horizon National Corp.

First Horizon recently reduced the credit scores and boosted the loan-to-value ratio allowed on limited and no-documentation loans that it sells to investors through Wall Street. The bank says such loans represent a tiny portion of First Horizon's volume.

The loosening of standards also shows up as products that were initially geared toward the most sophisticated borrowers -- such as option ARMs and interest-only loans -- have become more mainstream. A recent analysis by UBS AG shows that the average credit scores for borrowers with option ARMs has declined over the past three years. In addition, more than 22% of the borrowers who took out option ARMs this year financed more than 80% of the purchase price, up from 12% of borrowers in 2004 and less than 2% in 2002, according to the UBS analysis, which looked at loans sold to investors.

Similarly, interest-only mortgages, which were first aimed at wealthy borrowers, are increasingly being offered to people with poor credit. Interest-only mortgages accounted for 30% of the subprime loans originated in April, according to UBS, up from 14% in all of 2004. Average credit scores and other measures of credit quality have also been declining, according to UBS.

REPORT: Real Estate Indicators and Financial Stability

BIS Papers No. 21, April 2005

The papers in the volume are grouped into broad thematic areas as they were discussed in the conference: review of the impact of real estate on monetary and financial stability, usefulness of available statistics, country experiences in the compilation of real estate price indices, methodological issues on residential and commercial real estate prices, hedonic real estate price indices, aggregation issues, valuation of real estate in special situations, and areas of future work. The volume also contains a summary of the discussion that took place at the conference on possible future areas for work. Transcripts of the discussions during the individual sessions of the conference are available upon request.

[MORE]

Flipping Exchange

By Matt Reed, USA TODAY

Converted apartments aren't the only hot spot in the nation's booming condominium market. In rapidly growing South Florida, new condos are traded almost like a commodity.

Entrepreneurs have launched two online exchanges where visitors can buy, sell and "flip" condos in a global marketplace.

"Condos are more and more being bought sight-unseen, based on price per square foot and the view," says Richard Swerdlow, CEO of United States Condo Exchange, or USCONDEX.

In the Miami area alone, developers have proposed as many as 70,000 units in glossy towers to be built in the next two to four years. The Web sites aim to move them in bulk, collecting commissions along the way:

USCONDEX.com. This Web site charges developers $2,500 per building per month to showcase existing and preconstruction condos. Potential buyers can search listings from West Palm Beach to Miami and negotiate online. This year, the site will launch live auctions, similar to eBay.

CondoFlip.com. This site helps buyers of unbuilt Miami condos find secondary buyers so they can sell the condos at a higher price, or "flip" them.

In a flip, the first buyer pays a deposit and signs an agreement with a developer to close on a condo when it is finished, sometimes a year or two later. As construction proceeds, the condo's value rises, new buyers want in and the original buyer can sell the unit for a profit moments after closing. Sellers pay a 4% commission for help brokering a flip.

Condo Flip founder Mark Zilbert says flipping can't work like day trades or commodity deals, when instant transactions happen online. Florida law requires contracts and paperwork to be signed and officially recorded.

Reed reports daily for FLORIDA TODAY in Melbourne, Fla.

NEWS: Renters must choose: Buy or goodbye

By Charisse Jones, USA TODAY

SAN DIEGO — For James DeForest, the transformation of his rented apartment into a condominium for sale offers a chance at the American dream.

"I called my mom and dad ... and let them know I could be a homeowner out here in California," says DeForest, 48, an operations coordinator for a Bed Bath & Beyond store, who hopes to buy his bungalow unit and carry a mortgage for the first time. He expects to pay at least $300,000.

For Valerie Shield, an elementary school principal in a different pocket of San Diego, the planned conversion into condos of an apartment complex where 75 of her students live means something less rosy: Many of their families will have to find new places to live.

"These are people cleaning hotel rooms, busing tables," she says. "They can barely make the $900 to $1,000 rent. ... I'm worried about the children."

Condo conversions such as these in San Diego's stratospheric housing market are gaining momentum in metropolitan areas around the nation. In places such as Miami, Las Vegas, Charlotte and Washington, D.C., developers are buying and renovating apartment buildings, then selling the units as condominiums.

The condos, often priced far less than new condominiums or single-family homes, offer some longtime renters a fleeting chance at homeownership. Tenants who can't scrape together a down payment or obtain financing must move.

"Conversions create opportunities for entry-level purchases," says Gabe del Rio of Community HousingWorks in San Diego, which helps low- and moderate-income families. "Then we also see the other side. These are the very low-income individuals who have usually been in that complex for a very long time. ... They don't have many options."

The rental-to-condo rush is particularly hot in Las Vegas, the nation's fastest-growing metro area. Ten thousand to 13,000 apartments were converted to condominiums last year in Clark County, which includes Las Vegas.

The lower prices of converted condos are a big draw for would-be home buyers. Converted condos in Las Vegas cost $90,000 to $150,000. The median price of a new single-family home there is $305,500.

Converted condos are attractive to empty-nesters who want to downsize, but they are most popular with first-time home buyers, particularly firefighters, teachers and others who earn moderate incomes in expensive markets, says Walter Molony, spokesman for the Chicago-based National Association of Realtors.

Some cities where condo conversions are underway have the nation's lowest apartment vacancy rates, triggering concerns among local officials that renters are being left with few places to go.

In the Washington area, the vacancy rate for multifamily rental units was 3.6% as of July 1, according to the Realtors group. The rate was 2.9% in Miami and 2.7% in San Diego. The projected national average vacancy rate this year is 5.7%.

"We are definitely concerned about the displacement (of tenants) and the loss of rental housing, particularly affordable rental housing," says Melodie Baron, division chief for the Office of Housing in Alexandria, Va. Since November, applications have been filed to convert 2,365 rental units in that city.

Here's what some cities are doing to ease the crunch:

• Alexandria is offering interest-free loans of as much as $40,000 to tenants with moderate incomes who want to buy their unit when it goes condo.

• Clark County in Nevada is allowing homeowners on lots of 5,000 square feet or more to build another structure that they could rent to people who are not family members.

• The San Diego City Council has set aside $1.9 million for loans to displaced renters who earn the area's median income of $64,000 a year or less. Displaced tenants receive three months' rent, which they can use for a down payment on a home or another rental.

DeForest was worried when he learned five months ago that his bungalow community was going condo.

"It was a little scary because everything is just sky-high here ... and I don't make a whole lot of money," he says. But he also saw a chance to become a homeowner.

Fiel Barrow, 29, who attends San Diego State University, paid $217,000 in April for a converted one-bedroom condo. He says he was able to buy only because of the relatively low cost of the condo and loans he obtained through programs for first-time home buyers.

Mayor Mark Lewis of El Cajon, a San Diego suburb where apartments make up 52% of housing, welcomes conversions. Conversions enable residents to put down roots, and they also increase tax revenue for city services, he says.

Art Madrid, mayor of neighboring La Mesa, isn't so sure conversions help his town. La Mesa ties the number of conversions it will allow to the number of apartments built in the previous two years. No apartments have been constructed in the past decade.

"I think we have a legal and moral responsibility to make sure that the residents who've lived here for years and years aren't displaced just for the sake of money," Madrid says.

[MORE]

NEWS: Mortgage Bankers: Desperate to Lend

BUSINESS WEEK
JUNE 27, 2005

By Peter Coy

Refinancing volume has tumbled, as has profitability, so these lenders offer increasingly sweet deals in a scramble for market share

One of the more puzzling aspects of the current housing boom is that mortgage lenders have been offering ever-sweeter deals on loans. These days it's increasingly easy to qualify for a loan with little or no money down.

The market is rife with interest-only loans, as well as "option ARMs" that allow borrowers to roll part of the interest they owe back into the principal on the mortgage (see BW Online, 6/16/05, "The Mortgage Trap"). It has gotten so bad that you hear anecdotes of some lenders not even requiring proof of income before handing over a million bucks to a homebuyer.

PROFITABILITY SLUMP. Why have lenders been so liberal when they run the risk that many of their marginal customers will go into default? The answer is surprising. Sure, long-term interest rates have at times continued to defy conventional wisdom and decline or hold steady while the Fed hiked short-term rates. This gives lenders a lot of room to keep their rates to customers as low as possible.

But it turns out that's just part of the reason lenders are offering such unbelievable deals to their customers. Many lenders are just plain desperate for business, according to some experts. In a bid for market share, mortgage lenders are offering highly favorable terms to borrowers. That's forcing the rest of the industry to match their terms or lose customers.

The industry's underlying problem is simple: Overcapacity and a drop in profitability from its all-time high of 2003. And that's not the claim of an industry gadfly. It's the analysis of the sector's own top economist, Douglas Duncan, the chief economist of the Mortgage Bankers Assn. Duncan told BusinessWeek on June 23 that profits fell by 70% from 2003 to 2004 among 70 lenders that supply their internal data to the trade group.

GREAT FOR BUILDERS. The Mortgage Bankers Assn.'s profit numbers are not available from any other source because most of the lenders are privately held and are not required to reveal their P&L's to the public. Several of the biggest lenders are publicly held and have performed better than the industry composite.

Many experts credit the availability of cheap loans to a wide swath of the public as one of the factors behind the enormous run-up in housing prices, especially in coastal states. In the U.S., homes' appraised value made up 145% of nominal gross domestic product in March, while stocks and mutual funds were worth 82% of GDP, according to the Federal Reserve.

That's great for homebuilders, who are reporting some of the best profits in years (see BW Online, 6/22/05, "Builders Keep the Home Runs Coming"). But earnings for lenders have fallen off because there's less refinancing than in the peak year of 2003.

OVERCAPACITY CONCERN. Yet in spite of the profit pressures, Duncan told BusinessWeek that he believes lenders on the whole are behaving responsibly. One reason: If lenders resell a mortgage into the secondary market and then the borrower defaults, they can sometimes be forced to buy the loan back, eating the loss. He says he's not worried that the industry is setting itself up for a wave of defaults.

Analyst Paul Miller of the brokerage firm of Friedman Billings Ramsey agrees, saying the big lenders are being prudent and refusing to make loans that would violate their own standards for minimum projected profitability.

Nonetheless, the numbers that Duncan cites show why overcapacity is a concern. The lending business simply doesn't have enough customers to support its current size. In 2003, the industry originated about $3.9 trillion worth of loans, Duncan says. Last year, that figure dropped to some $2.6 trillion because interest rates rose, so although the new home market was hot, fewer people applied to refinance existing mortgages.

That left lenders with "lots of excess capacity," he told BusinessWeek. While lending might go up slightly in 2005, he says, it still won't be anywhere near the 2003 peak.

BILL WITH POOR PROSPECTS. Says analyst Miller: "The industry keeps coming up with cheaper and cheaper products to keep the pipeline full." Even after layoffs, "there are companies that are still too fat," he says. He predicts that some smaller firms will go bust if lending shrinks this year or next.

Congress is considering a proposal that would give the federal government authority over lending practices. Currently the practices are governed by a patchwork of state regulations. The bill before Congress was introduced partly because of worries about foreclosure rates and whether lenders are ensuring that borrowers have adequate resources to repay loans. Most experts don't give the bill much chance of passing.

Still, the next time someone dangles an incredible loan offer in front of your face, you'll have a better idea why.

[MORE]

NEWS: Higher Odds Of Regional Housing Busts

By RUTH SIMON and JAMES R. HAGERTY

Staff Reporters of THE WALL STREET JOURNAL

June 20, 2005; Page A8

A report by Fannie Mae says the probability of housing busts has "risen sharply in certain parts of the country," partly because of looser lending standards.

The report, presented to a group of home builders in Washington last month but not yet released publicly, finds conditions in many parts of the country "mirror past conditions that preceded regional housing busts." Among other things, it cites increases in the number of riskier loans, including ones that allow buyers to delay repaying the principal or that aren't backed by full documentation of the borrower's income and assets.

The report adds, however, that it is impossible to know whether there is a housing "bubble" until after the fact.

The analysis is notable because Fannie and the smaller Freddie Mac are the nation's biggest purchasers of mortgage loans. The two government-sponsored companies buy loans from lenders and package them into securities for sale to investors. They have long played a big role in setting standards for home loans.

Their ability to set standards, however, is eroding rapidly as they lose market share to private-sector rivals. Fannie and Freddie helped finance about 43% of new home mortgages in 2004, down from 59% a year earlier, according to Inside Mortgage Finance, an industry publication. Lenders increasingly are selling loans to rivals with more flexible credit standards. Fannie's capacity to buy loans also has been hampered by its need to shore up capital in the wake of an accounting scandal.

The Fannie analysis shows a loosening of standards for loans included in "private-label" mortgage securities, those that aren't backed by Fannie, Freddie or Ginnie Mae, a government agency that guarantees payments on federally insured loans.

The shifts are particularly notable for home-purchase loans to people with blemished credit records. Nearly 24% of the total value of "subprime" loans included in private label securities last year were adjustable-rate mortgages with an interest-only payment feature. On such loans, borrowers don't need to pay down the principal in the early years. Interest-only mortgages are considered riskier because borrowers don't build up any equity during the interest-only period and face sharply higher payments once they have to start paying back the principal.

Debt loads also are climbing. Mortgage borrowings rose to an average of 91% of the home value last year, from 85% in 2001. If home prices fall, high debt levels make it more likely a house will be worth less than the mortgage balance.

The report found similar shifts among home buyers taking out mortgages larger than the maximum size purchased by Fannie and Freddie, currently $359,650. For instance, the share of "jumbo" mortgages issued with full documentation of the borrowers' income and assets fell to 49% last year from 73% in 2001.

Of course, Fannie could hope to gain by questioning rivals' practices. Asked about that, a spokeswoman said "a chorus" of voices is raising concerns about "the layering of risks." What is more, Fannie and Freddie do buy interest-only loans and mortgages without full documentation.

The report says lending patterns of the past year are similar in some ways to those of the late 1980s, shortly before prices fell in parts of the U.S., including Southern California and New England.

Table: Easier Money
Percentage of subprime home-purchase laons with interest only payments
2001 0%
2002 1.8%
2003 8.2%
2004 23.5%

Percentage of fully documented income and assets for home purchase loans

2001 70.4%
2002 60.9%
2003 57.6%
2004 55.1%

Note: Data are for home purchase loans in mortgage securities not guaranteed by Fannie Mae, Fredie Mac, or Ginnie Mae.

Sources: Fannie Mae, UBS, LoanPerformance

NEWS: Booming Local Housing Market

Weigh Heavily on Overall Sector

By GREG IP

Staff Reporter of THE WALL STREET JOURNAL

June 20, 2005; Page A1

New federal housing data show that the nation's most overheated local housing markets now make up such a large share of the total U.S. market that a sharp fall in their values could stall or slow national economic growth.

The 22 major metropolitan markets with the fastest-growing house prices account for 35% of the value of the nation's residential real estate, but just a fifth of its population, says the Federal Deposit Insurance Corp.

Their share of the national real-estate market has risen quickly. In 2000, the 22 markets accounted for 27% of all U.S. residential real estate. In 1995, the figure was just 24%.

Some economists say local bubbles are less worrisome than a nationwide one because they are more likely to pop individually, in response to local events, reducing the national fallout. And Federal Reserve Chairman Alan Greenspan recently has said that the U.S. has no national housing bubble, but there are "signs of froth in some local markets."

But the latest data suggest that real-estate values in the nation's fastest-growing markets are getting so large that the distinction between them and the national market could become meaningless.

"It's a widespread boom and has macro implications," says Richard Brown, chief economist of the FDIC. "A slowdown would not only hurt these markets, but the U.S. as a whole." (See related article1.)

Says Mark Zandi, chief economist at Economy.com, a consulting firm specializing in regional economic analysis, "If you tote up the metropolitan areas that are bubble-like, it's closing in on half the housing stock. Another year of these price gains and I think it would qualify as a national house price bubble even though not every corner of the country is experiencing speculative activity."

The FDIC considers a local market to be a boom market if it has appreciated 30% or more, adjusted for inflation, in the past three years. It says 55 of the country's 362 local metropolitan markets qualified in 2004. Together, they accounted for roughly 40% of all the value of residential real estate in the country -- up from about 30% in 2000.

The agency has detailed data for only 22 of those 55, though they include most of the largest and among the priciest of those 55 markets. The two largest metropolitan areas, New York and Los Angeles, each have a value of more than $1 trillion. Adding in the Boston, Washington, D.C., and San Diego metropolitan areas, the top five boom markets are valued at $4 trillion, or 24% of the national total, while those markets represent just 12% of the U.S. population of 294 million.

FDIC economists prepared the local estimates at the request of The Wall Street Journal. The FDIC is an independent federal agency that provides insurance for most bank deposits and regulates state-chartered banks that aren't members of the Federal Reserve system.

The disproportionate concentration of housing wealth in a few markets is reminiscent of how a few technology and blue-chip companies drove the bull and bear markets in stocks starting in the late 1990s.

The Standard & Poor's 500-stock index rose 45% from the end of 1997 to February 2000, but the average stock rose just 14%. Over the next three years, as technology companies plummeted, the index fell 36%, but the average stock fell just 2%, according to Aronson+Johnson+Ortiz, a Philadelphia money manager.

At the same time, houses are unlikely to fall anywhere near as sharply as stocks can. That's because it's costly for families to move, and sellers are more likely to take a house off the market if they can't get an acceptable price.

If the 55 boom markets declined 15% while the rest of the country was flat, national housing prices would drop 6% -- on a par, adjusted for inflation, with previous national housing pullbacks, but hardly a crash.

Unlike stocks, the housing market "would be more likely flat with 10% to 20% declines in some regions, or down slightly nationally with some regions looking ugly," says Ethan Harris, chief U.S. economist at Lehman Brothers. Even local housing crashes take years to unfold, he says.

Still, a flat housing market could damp overall economic growth by restraining new construction and consumer spending financed by borrowing against home values. Mr. Harris estimates that if the overheated local markets declined 10% a year for three years, while the rest of the country rose 5% a year, it would reduce U.S. economic growth from 4% to about 2.5%.

Federal Reserve officials expect housing prices eventually to level off and restrain consumer spending. But they believe business investment and exports will increase by then and pick up the slack, maintaining overall growth for the U.S. economy.

Though the U.S. hasn't experienced a serious, nationwide decline in home prices in the past three decades, many local markets have fallen sharply. Prices rose sharply in Southern California in the late 1980s, then collapsed in the early 1990s as the economy reeled from a national recession and deep cuts to defense spending.

"Our economy, especially in Los Angeles County, was devastated," says Michael Bazdarich, senior economist at UCLA Anderson Forecast, an economic research center at the University of California at Los Angeles. The defense cuts alone would have caused a serious local recession, he says. But those cuts along with a reversal in home prices "combined to wreak havoc on the local economy." The damage was amplified by mortgage defaults that brought down the region's largest savings and loan institutions.

Mortgage defaults remain low, but a reversal in home prices could change that. Goldman Sachs mortgage analysts say a delinquent borrower in a rising market can use the equity in his home to qualify for a new loan, but loses that option when prices stagnate or decline.

Goldman Sachs studied the experience of Southern California's Orange County, where subprime mortgages -- those issued to less-creditworthy borrowers -- issued in 1992 defaulted at far above the national average, while subprime mortgages issued in 1999, during the current boom, defaulted far less. They estimate that in a region with strong price appreciation now and a subprime default rate of about 1%, several years of declining prices could push defaults to 8% to 10%.

But analysts say even overheated local markets are unlikely to suffer as much as Southern California did a decade ago. The FDIC's Mr. Brown defines a housing bust as a decline of 15% or more, unadjusted for inflation, over five years. For that to happen, he says, "historically, you need severe local economic conditions." The markets where house prices are appreciating the most "are pretty well diversified economies" that don't depend heavily on a single industry like defense or energy, he says.

However, the FDIC cautions that in the past year, national factors such as low mortgage rates and easier lending standards are displacing local factors in driving home prices, so previous experience may be less useful.

Mr. Zandi of Economy.com adds that local housing collapses in New England and Southern California in the late 1980s and early 1990s "infected the broader banking system." Banks today are better capitalized, and thanks to consolidation, less exposed to any single region, he says. Moreover, banks have "securitized" many of their mortgages -- that is, repackaged them as standalone securities and sold them to investors and to federally chartered companies Fannie Mae and Freddie Mac.

But for the same reason, he warns, "No one really has a grip on who has the risk." If something goes wrong in the mortgage market, a lack of transparency could cause investors to shun good and bad borrowers alike, he says.

The low long-term interest rates of recent years are a key factor tying all local bubbles together in the U.S., says Edward Leamer, chief economist at the UCLA Anderson Forecast. If those rates rise sharply, they will "kill off those bubbles all at the same time."

David Lereah, chief economist at the National Association of Realtors, says a local market becomes most vulnerable to collapse when it experiences rapid price appreciation, rising inventories of unsold homes and a high concentration of lending on loose terms, such as interest-only mortgages.

At present, he says, no market is experiencing a "meaningful" rise in inventories -- in fact, the hottest markets tend to have less inventory than average. He says those markets also tend to have the most limited supply of new housing because of land shortages or regulatory constraints.

Booming northeast and California housing markets dominate national real-estate value

Area (Bolding indicates boom market)	Estimated Value (in billions)	Share of U.S. Market*	Share of U.S. Population
Los Angeles-Long Beach CA PMSA	$1,171.4	6.8%	3.4%
New York NY PMSA	1,145.7	6.6%	3.2%
Boston MA-NH PMSA	720.9	4.2%	2.1%
Chicago IL PMSA	631.9	3.7%	2.9%
Washington DC-MD-VA-WV PMSA	562.4	3.3%	1.8%
Orange County CA PMSA	497.8	2.9%	1.0%
San Diego CA MSA	469.8	2.7%	1.0%
San Francisco CA PMSA	350.1	2.0%	0.6%
Nassau-Suffolk NY PMSA	323.1	1.9%	1.0%
Riverside-San Bernardino CA PMSA	311.4	1.8%	1.3%
Philadelphia PA-NJ PMSA	299.2	1.7%	1.8%
Seattle-Bellevue-Everett WA PMSA	242.5	1.4%	0.9%
Newark NJ PMSA	224.1	1.3%	0.7%
Atlanta GA MSA	214.2	1.2%	1.5%
Minneapolis-St. Paul MN-WI MSA	206.4	1.2%	1.1%
Baltimore MD PMSA	202.5	1.2%	0.9%
Phoenix-Mesa AZ MSA	196.9	1.1%	1.2%
Miami FL PMSA	194.8	1.1%	0.8%
Houston TX PMSA	182.1	1.1%	1.6%
Sacramento CA PMSA	179.3	1.0%	0.6%
Fort Lauderdale FL PMSA	172.8	1.0%	0.6%
Denver CO PMSA	171.2	1.0%	0.8%
Dallas TX PMSA	161.3	0.9%	1.3%
Las Vegas NV-AZ MSA	157.1	0.9%	0.6%
Tampa-St. Petersburg-Clearwater FL MSA	153.5	0.9%	0.9%
Portland - Vancouver OR-WA PMSA	137.4	0.8%	0.7%
New Haven-Bridgeport-Stamford-Danbury-Waterbury CT NECMA	135.1	0.8%	0.6%
St. Louis MO-IL MSA	109.2	0.6%	0.9%
Orlando FL MSA	101.7	0.6%	0.6%
Kansas City MO-KS MSA	90.2	0.5%	0.6%
Pittsburgh PA PMSA	89.1	0.5%	0.8%
Cincinnati OH-KY-IN PMSA	78.7	0.5%	0.6%
Indianapolis IN MSA	67.1	0.4%	0.6%
San Antonio TX MSA	61.4	0.4%	0.6%
Total for Largest Markets	$10,012.4	58.1%	39.5%

PMSA = Primary Metropolitan Statistical Area
MSA = Metropolitan Statistical Area

*Based on median values and number of units method

Source: Federal Deposit Insurance Corp.