Case-Shiller home price index continues to slump but is not falling as fast as before.

The S&P Case-Shiller home price index for May 2008 was released today by Standard and Poors. The composite-10 declined 0.91% from April and declined by 16.87% from May 2007. The composite-10 is now down 19.80% from its peak. All 20 individual markets are still down year over with Las Vegas and Miami down the most at -31.41% and -31.22% respectively. Charlotte and Dallas are down the least at -2.00% and -3.84% respectively. 7 markets were up in May compared to the previous month (Denver, Boston, Atlanta, Minneapolis, Charlotte, Portland, and Dallas). The markets with the biggest declines from the peak are also declining the fastest. The markets with smaller declines from the peak mostly rose last month or had a minor decline. The composite-10 is now down -19.80% from its peak. 9 markets have now dropped over 20% from their peak. The CME futures market is pricing in a further drop of -13.78% by next May for the composite-10.

It is encouraging that some markets are posting month over month gains. The month to month change in the composite-10 has also improved from February when it declined by 2.80% in one month to a 0.91% decline last month over the previous month. However, the home price index is not seasonally adjusted. In the last 20 years, home prices have averaged appreciation of 5.29% a year. March through August are typically the strongest months for appreciation and home prices have on average appreciated by 4.40% during that 6 month period. September through February are the weakest months; home prices have on average appreciated by only 0.89% during that 6 month period. In 2007, the declines were moderate in the first half of the year and started rapidly declining in August. Autumn and Winter will be a better indicator to see if the market is finding a bottom.

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Existing home sales slows to lowest level in 8 years

The National Association of Realtors released the existing home sales figures for June 2008 today. Sales increased to a seasonally adjusted annual rate of 4.860 million units in June, down 2.6% from May 2008 and down 15.5% from June 2007. This is the lowest annual sales rate since July 2000. For the first 6 months this year, only 2.386 million units have sold. The median sales price was $215,100 in June up from $207,900 in May 2008 (up 3.5%) but down from $229,000 in June 2007 (down 6.1%).

The inventory of existing homes grew to 4.490 million units up from 4.482 million in May 2008. Month's supply grew to 11.1. Lawrence Yun, NAR chief economist, said "with short sales and foreclosures accounting for approximately one-third of transactions, it’s hard to make an apples-to-apples comparison with a year ago when they were only a minor portion of the market." Distressed sales are pressuring prices, but they are also boosting sales transactions.

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Option ARMs are no longer being ignored

In January I posted that Option ARMs would be the next storm in the mortgage crisis. At that time, I felt that the dangers of Option ARMs were being ignored. Six months later, the situation is quite different. The Non-Performing Assets (NPAs) have nearly doubled from 2007 Q4 to 2008 Q2. Moreover, the deterioration seems to be accelerating.

Here is an update of the top 10 of Option ARM lenders of 2007. 5 of out of 10 no longer in the business: Countrywide (bailed out by BofA), American Home Mortgage, IndyMac, Capital One (shut down mortgage division), and Luminent Mortgage. Most of the others are struggling for their existence.

On Tuesday Wachovia announced $6.1 billion in writedowns. However, two analysts called the bottom on the stock and the stock rallied by nearly 30%. I think it is too early to call the bottom for many reasons:

The deterioration of the Option ARM portfolio is accelerating. Non-Performing Option ARMs grew to 5.8% in Q2 (pg. 15). In addition 3.9% of the Option ARMs are more than 30 days past due and 1.3% are more than 60 days past due.

Wachovia has a portfolio of $122.026 billion in Option ARMs (pg. 16). The average LTV at origination was 71%. It has deteriorated to 85%. With falling housing prices, Wachovia projects the LTV to reach 99% at the bottom. 58% of Wachovia's Option ARM portfolio is in California ($71.211 billion). The average LTV was 70% at origination and is now 90%. Wachovia projects the California LTV to deteriorate to 104%. Any second mortgages or further negative amortization will further increase the problem.

Wachovia's commercial division is also experiencing a surge in Non-Performing Assets. Their Real Estate Financial Services division has seen an increase in NPAs from 0.46% in Q2 2007 to 3.95% in Q1 2008 to 5.1% in Q2 2008 (pg. 47). This division has $48.355 billion in assets.

In June of 2007, Wachovia was touting their 10 year recast and 125% balance limit. As chronicled in this post, other lender's Option ARMs are starting to recast. The loan Wachovia used as an example until 2011. However when it does recast, the ramifications will be a lot worse. The balance will have grown from $250,000 to $325,000. The payment will jump from an initial payment of $804 to around $2500.

Wachovia's Option ARM borrowers are already struggling as reflected in their rising delinquencies. Their credit scores are also deteriorating. The average Option ARM borrower's FICO at origination was 675 compared to the current average FICO of 661 (pg. 34). For Wachovia's traditional mortgages, the FICO improved slightly from 731 at origination to 732 currently. If borrowers are struggling during the low payment period, how are they going to react when their payments triple and Wachovia projects that many will be underwater?

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30 year fixed rates jump to 6.71%; Congress has reached agreement on rescue bill

Interest rates on Conforming 30 year fixed-rate mortgages rose to 6.71% on Tuesday, up from 6.44% last Friday according to HSH Associates. For 35 year from 1967 to 2002, 6.5% was the lowest the rates had been. Rates reached 18.8% during the 1982 recession. Rates jumped because of concern about the financial health of Fannie Mae and Freddie Mac.

The government is actively firming up plans to make the implicit government backing of Fannie Mae and Freddie Mac explicit.  The federal government has already proposed a rescue plan and Congress has reached agreement on the plan on Tuesday per a report on Bloomberg:

Under a modified version of proposals made by the Bush administration, the Treasury Department would gain authority to inject capital into the two largest U.S. mortgage finance companies, through loans and equity investments.

The Treasury would be barred from providing aid that would cause a breach in the federal debt ceiling under the agreement, a constraint aimed at limiting any taxpayer losses. The debt limit would be raised to $10.6 trillion from the current $9.815 trillion.

The legislation would also raise the limit on the size of the mortgages the companies may purchase. The new cap would be $625,000, or the median home price plus 15 percent, whichever is lower, Frank said.

A Congressional Budget Office estimate released today put the cost of Paulson's plan at $25 billion, a figure below the total that some lawmakers had expressed concern about.

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Sales and use tax collection still shrinking

Sales and use tax collection continues to decline after adjustments for inflation.  Using a weighted composite for the four largest states (California, Texas, New York, and Florida), the decline in real growth improved slightly from an annual decline rate of -2.41% in May to -2.20% in June. Texas grew at a rate of 4.16% in June after adjustments for inflation which is down from the hot pace of 8.37% it averaged for 2007. New York, dipped back to negative growth after seeing year over year growth for four months in a row.  California's decline slowed to -4.88% in June up from -5.85% in May.  California declined on average of -2.03% in 2007. Florida continued its steady fall, declining -8.34% in June. Florida averaged a decline of -2.70% in 2007.

Spending is taking a turn for the worse after almost making breaking into the positive side in April.  It is looking like America will not be able to stave off the looming recession.

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New home permits and starts surge higher due to NYC building code changes

The U.S. Census Bureau and the HUD Department announced the new homes construction stats for June 2008 today. Total building permits were at a seasonally adjusted annual rate of 1,091 and was 11.5% higher than May 2008 but was down 23.9% from a year ago.  Per the U.S. Commerce Department, "A new construction code that took effect in New York City on July 1 prompted builders to start construction on, and seek permits for, condos and apartments a month earlier."  1 unit permits were at a seasonally adjusted annual rate of 613,000 which was down 3.5% from last month and down 39.7% from a year ago.  1 unit permits are at their lowest annual rate since January 1991.

Total housing starts were at a seasonally adjusted annual rate of 1,066,000 which was up 9.1% over the previous month, but 26.9% below April 2007.  Again the increase was due to the NYC building code changes.  1 unit starts were at 683,000 which is down 5.3% from May 2008 and down 43.0% from a year ago.  Housing completions were at a seasonally adjusted annual rate of 1,167,000 (1 units were at 859,000) which was 1.2% higher than the previous month, and 21.7% below June 2007.

Excluding the New York City market, home builders are continuing to pare down their construction in order to shrink supply to meet the low demand.

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Inflation surges to highest level since 1991

The U.S. Department of Labor reported the inflation numbers for June yesterday. Before seasonal adjustments, the Consumer Price Index for All Urban Consumers (CPI-U) rose 1.01% in June over May and was 5.02% higher than June 2007. Core CPI (CPI less food and energy) before seasonal adjustments was up by 0.17% compared to May and up 2.41% compared to a year ago. Seasonally adjusted, CPI-U rose 1.06% over May versus expectations of 0.7% and core CPI rose 0.32% instead of 0.2% expected by economists.

The surge in CPI-U was due to energy prices. Energy increased 6.6% in June over May. So far the rises in food and energy have not translated to surges in core CPI.

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PPI surges higher in June

The Bureau of Labor Statistics released the Producer Price Index for Finished Goods (PPI) today. Seasonally adjusted, PPI increased by 1.79% in June 2008 compared to May. PPI was 9.06% higher than a year ago, which is the highest PPI has been since 1981. The median analyst expectation for month over month PPI was 1.4%. Core PPI (PPI less food and energy) was up 0.24% compared to May and was 3.09% higher than a year ago. This is the highest core PPI has been since 1991. The median analyst expectation for month over month core PPI was 0.3%. Inflation pressures continue to rise even as the economy is weakening.

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A wild week for Fannie and Freddie

Freddie Mac and Fannie Mae saw their shares get cut almost in half last week.  Freddie Mac's stock tumbled from a close of $14.50 on July 3rd to trading as low as $3.89 last Friday before recovering to $7.75. Fannie Mae went from $18.78 on July 3rd to as low as $6.68 last Friday before closing at $10.10. The freefall was kickstarted on Monday when Lehman Brothers analysts wrote a note to clients:

The new FAS 140 rule that seeks to stop companies keeping assets in off-balance sheet entities may force Fannie Mae and Freddie Mac to bring mortgages back onto their books, requiring them to put up capital, Lehman analysts led by Bruce Harting wrote in a note to clients today. Fannie Mae would need to add $46 billion of capital and Freddie Mac would need about $29 billion, the Lehman analysts wrote. The companies will probably get an exemption from the rule because it would be ``very difficult'' for them to raise that amount of capital, the analysts said.

Fannie Mae and Freddie Mac shares rebounded on Tuesday possibly in part because the market realized that the analyst also said that the companies would probably get an exemption from the rule. James Lockhart, the director of the Office of Federal Housing Enterprise Oversight, also said on Tuesday that "Fannie and Freddie are adequately capitalized at this point."

On Wednesday Fannie Mae paid a record yield of 74 basis points over the U.S. Treasuries. This was triple what they paid in June 2006. Credit-default swaps tied to their AAA rated debt were trading at levels implying their debt should be rated A2 instead. Also on Wednesday, William Poole, former St. Louis Federal Reserve President said that:

Freddie Mac is technically insolvent under fair value accounting, which measures a company's net worth if it had to liquidate all its assets to repay liabilities. Fannie Mae may become insolvent this quarter, Poole said, increasing pressure on the government to instigate a rescue. Freddie Mac owed $5.2 billion more than its assets were worth in the first quarter, making it insolvent under fair value accounting rules. The fair value of Fannie Mae's assets tumbled 66 percent to $12.2 billion and may be negative next quarter, Poole said.

On Sunday, the U.S. Treasury announced a plan making the implicit guarantee explicit.  Here is Treasury Secretary Henry Paulson's statement:

Fannie Mae and Freddie Mac play a central role in our housing finance system and must continue to do so in their current form as shareholder-owned companies. Their support for the housing market is particularly important as we work through the current housing correction. GSE debt is held by financial institutions around the world. Its continued strength is important to maintaining confidence and stability in our financial system and our financial markets. Therefore we must take steps to address the current situation as we move to a stronger regulatory structure. In recent days, I have consulted with the Federal Reserve, OFHEO, the SEC, Congressional leaders of both parties and with the two companies to develop a three-part plan for immediate action. The President has asked me to work with Congress to act on this plan immediately. First, as a liquidity backstop, the plan includes a temporary increase in the line of credit the GSEs have with Treasury. Treasury would determine the terms and conditions for accessing the line of credit and the amount to be drawn. Second, to ensure the GSEs have access to sufficient capital to continue to serve their mission, the plan includes temporary authority for Treasury to purchase equity in either of the two GSEs if needed. Use of either the line of credit or the equity investment would carry terms and conditions necessary to protect the taxpayer. Third, to protect the financial system from systemic risk going forward, the plan strengthens the GSE regulatory reform legislation currently moving through Congress by giving the Federal Reserve a consultative role in the new GSE regulator's process for setting capital requirements and other prudential standards. I look forward to working closely with the Congressional leaders to enact this legislation as soon as possible, as one complete package.

Fannie and Freddie were brought to their knees by declining home values.  The decline in home prices may be half way done.  If that is the case, it is hard to value how large this assistance to the GSEs will become.  However, with the GSEs holding or guaranteeing $5 trillion in mortgages, the number could be staggering.

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Initial Unemployment claims decrease but overall employment is still weak

The U.S. Department of Labor released the Weekly Claims data for Unemployment Insurance today. Initial claims were at 346,000 for the week ending July 5th. The four week average of initial claims, which is not as volatile, was at 380,500 down from the previous week's mark of 390,500. This is the highest the initial claims has been since Hurricane Rita in 2005 and the end of the 2003 when the economy started to recover from the 2001 recession.

Continued claims for unemployment insurance increased to 3,202,00o for the week ending July 5th up from the previous week's number of 3,111,000. The four week average for continued claims was also up to 3,145,000 from 3,109,250. This is the highest it has been since 2003.

Unemployment claims reflect the rise in the unemployment rate. According to "The Employment Situation" for June 2008 released by the U.S. Department of Labor, the unemployment rate was 5.5% in June unchanged from May. Since 1948, the unemployment rate has never risen by more than .5% without entering into a recession. The unemployment rate is now up 0.9% in the last twelve months.

Nonfarm payrolls decreased by 62,000 in June and decreased by the same in May. Nonfarm payrolls have declined for 6 straight months shedding 438,000 jobs. Over the last ten years, nonfarm payrolls have increased by an average of 107,000 jobs. Nonfarm payrolls rarely decrease outside of recession periods and it is even more rare for consecutive declines. Excluding periods right before, during and after recessions, nonfarm payrolls have declined consecutively only two times: 3 consecutive times in 1951 and 2 consecutive times in 1952.

It now looks like a recession is unavoidable. The good news is that employment has held up fairly strong so far. The bad news is that employment will probably continue to slide.

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Pending Home Sales are down again in May

The Pending Home Sales Index for contracts signed in May 2008 on a seasonally adjusted basis was at 84.7 down 4.72% compared to April 2008 when it was at 88.9 and were down 14.01% compared to May 2007's figure of 98.5. Without seasonal adjustments, the index was down 14.64% compared to May 2007.

2001 was previously the slowest year for pending home sales on record. May 2008 was 17.38% below May 2001's sales pace. April 2008 was only 10.89% below the 2001 level. Lawrence Yun, NAR chief economist said that "some pullback after a sharp increase in the previous month was expected." Of course he didn't say that in last month's press release. The NAR raised their 2008 median home sales price forecast from $205,000 to $205,300. Last month they dropped their forecast by 4.1% from $213,700 to $205,000.

April, May and June are the three biggest months for Pending Home Sales. Afterwards, sales quickly taper off. Pending Home Sales for May indicates that the June and July existing sales will also be flat. Existing home sales seemed to have reached a bottom in terms of units sold while the Case-Shiller home price index shows prices are continuing to fall. It will be interesting to see what happens to home sales when the activity starts to lessen.

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Non-manufacturing index slumps back to recessionary level

The Institute for Supply Management released their June 2008 Non-Manufacturing ISM Report on Business today. The Non-Manufacturing Index (NMI) came in at 48.2%. 50% is the breakpoint for growth. NMI had plunged to 44.6% in January 2008 but had rebounded above 50 for the previous 2 months.

NMI is made up of four components: business activity, employment, new orders, and supplier deliveries. Business activity was down from 53.6% in May to 49.9% in June; employment was down from 48.7% to 43.8%; new orders was down from 53.6% to 48.6%; and supplier deliveries was down from 51.5% to 50.5%.

Here is what some of the respondents to the survey were saying:

• "Oil prices are affecting most every supplier we have." (Transportation & Warehousing)


• "Energy costs are beyond the pain point. They are disruptive to every part of our business." (Agriculture, Forestry, Fishing & Hunting)


• "Challenging due to continuing cost pressure from suppliers. Planning on decreased production activity as summer wears on and budgets tighten." (Other Services*)


• "High cost of commodities, fuel prices, are impacting margins and economic conditions are negatively impacting traffic counts and average check amounts." (Accommodation & Food Services)


• "Energy cost is starting to have an effect on cost of products from all sectors." (Wholesale Trade)

In the last few months, businesses seemed to be thinking we were going to avert a recession. Now high prices coupled with the housing crisis is swinging sentiment back to the recession camp.

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Withheld Taxes show income still growing but at a slow rate.

The amount of withheld taxes received by the Department of the Treasury for a 12 month period ending June 2008 was 2.39% higher than a year ago after being adjusted for inflation. This is up slightly from May's rate of 2.20%. Through the last cycle, the year over year growth rate of withheld taxes closely mirrored the stock market. The real growth rate turned negative just as the recession ended. It wasn't until the end of 2002 and the beginning of 2003 that the growth rate bottomed and started to improve. The stock market also started growing at the same time. Currently real withheld taxes is growing year over year, but the trend is downward.

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PMI comes in strong at 50.2%

On Tuesday, the Institute for Supply Management released their monthly Manufacturing ISM Report on Business. The Purchasing Managers' Index (PMI) came in at 50.2% for June which was 0.6% higher than May.

A PMI reading of 50.2% suggests that the manufacturing economy is growing just a tad. Per ISM:

"A reading above 50 percent indicates that the manufacturing economy is generally expanding; below 50 percent indicates that it is generally contracting. A PMI in excess of 41.1 percent, over a period of time, generally indicates an expansion of the overall economy."

This breaks a streak of 4 months under 50. Economists had expected PMI to come in at 48.6%.

Here is what some of the respondents to the ISM survey are saying:

• "The shock waves from high crude price continue to put pressure on derivative pricing." (Chemical Products)
• "Business appears to have bottomed out." (Transportation Equipment)
• "Seeing renewed interest in outstanding quotes." (Machinery)
• "Volume is normal, and we are able to recover some of the raw material (steel cost) increases." (Fabricated Metal Products)
• "Commodity bubble is killing profitability." (Food, Beverage & Tobacco Products)
• "Orders have slowed, and prices for metals are going up." (Computer & Electronic Products)

Manufacturing and business are not leading us into a recession. It is the housing crisis and the consumer being hit hard by energy and food prices that is dragging the economy down. Manufacturing has held up its end so far.

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