Today's Tidbits

May 2, 2007 TIDBITS

Increased Use of MBS Changes Foreclosure Landscape (Average Cost $80,000)
From Business Week: “Many of the homeowners in trouble are fist-timers who bought recently or investors who got in over their heads….For the first time in years, houses are hitting the market with asking prices below the value of their mortgages. Stretched owners are hoping for a so-called short sale, in which the lenders forgive the difference. National statistics are scarce… In Sacramento, real estate agent…counts 1,079, more than 10% of the total homes on the market. ‘If home values are falling, short sales are better because they can be done cheaper and quicker [than foreclosures],”…Quick is good, given the unprecedented pressures lenders are facing. In previous downturns, most loans were owned by federally insured lenders. Now roughly 56% of all loans outstanding, $5.7 trillion worth, have been pooled into mortgage-backed securities, vs. just 12% in 1980. “Wall Street has been very tough, and it’s encouraging lenders to act rapidly,” says Douglas G. Duncan, chief economist for the Mortgage Bankers Assn. “The faster you act, the lower the losses.” With so much at stake, lenders are scrambling to cut delinquencies and avoid foreclosures…a unit of Bear, Stearns & Co., recently set up a “Mod Squad” team - short for loan modification – of 50 workout specialists who travel the country helping homeowners renegotiate…face-to-face meetings with borrowers before there is a problem…”We want to protect the loan for going all the way south.” That is good for everybody. Each foreclosure costs lenders, the government and homeowners an estimated $80,000. Even neighbors take a hit, since foreclosure can have a ripple effect on property values. One foreclosure can cut the price on nearby homes by 1.4%. Still, with so many loans packaged and sold as pools, the industry has tied its hands to some extent. To take advantage of the accounting and tax benefits, many lenders wrote restrictions on the mortgage-backed securities; generally just 5% of loans in such investments can be renegotiated. Some pools containing subprime loans already have delinquency rates of 8% or more. It’s possible to change the deal, but it’s time consuming and costly. “What was once a simple, often personal relationship between a borrower and lenders is now a complex structure involving many parties, including services, investors, trustees, and rating agencies,”…By keeping borrowers in houses they never should have bought, lenders could simply be setting everyone up for a steeper fall down the road.”

Housing Glut Raises Rental Vacancy Rates
From Bloomberg: “The glut of U.S. properties for sale is about to hit the rental market. A record number of homeowners who can't sell condominiums and houses are competing for tenants with the country's biggest apartment owners… ``Competition already is forcing the big apartment owners to offer concessions like two months free rent,'' McCabe said. Vacant rental apartments rose to 6.1 percent in the U.S. during the first quarter, the most in almost two years… Nationwide, 2.8 percent of houses for sale were unoccupied in the first quarter, the highest since the Census Department started collecting the data in 1956. Unsold properties on the market totaled a record 3.45 million in 2006, according to the Chicago-based National Association of Realtors. ``Unsold properties being turned into rental units are creating a shadow market that's driving up the vacancy rate and slowing the growth of rents,'' …``Areas that saw the most speculative investing, particularly in condos, will see the biggest pressure on rents.''…

Equity Rally Led By “Defensive” Stocks
From Merrill Lynch: “One heck of a "defensive rally" in stocks: since the February 27th low, outside of energy, three of the best performing sectors have been utilities (+9.4%), health care (+8.1%) and telecom services (+6.6%). What type of "cyclical" developments are equities pricing in exactly when utilities are the second best performing sector, followed by health care? These tend to do well in economic slowdowns – so maybe, despite the headline indices, the action beneath the surface is actually quite consistent with our view of lingering economic malaise in the USA. The bottom performers during the rally have been consumer cyclicals, which have underperformed the broad market by 350 basis points – that represents the stock market's feeling on that 70% share of the US economy otherwise known as the resilient consumer. And the other two bottom performers have been materials, another economic-sensitive, and financials – the latter underperforming since late February by nearly 250 bps in an environment of broadly stable bond yields. Could that be telling us something about the stock market's view towards credit quality? Rallies that are not led by financials or consumer discretionary but instead by utilities and health care are rallies that don’t generally point in the way of economic reacceleration… That the market would hit its cycle highs – all-time highs for the Dow – in the aftermath of the weakest GDP quarter since 2003Q1 and the softest earnings trend since 2002Q1 speaks volumes.”

From The International Herald Tribune: “Money is flowing into alternative energy companies so fast that "the warning signs of a bubble are appearing,".. the amount of venture capital put into clean energy investments last year was $1.5 billion, up 141 percent from the $623 million of 2005, and that in the same period, initial public offerings by companies in this sector rose to $4.1 billion, from $1.6 billion in 2005. The initial public offerings were primarily in companies involved in solar power or biofuels…”

Grantham (Manages VP Cheney’s Investments) Sees Bubbles Everywhere
From Bloomberg: “…Grantham make one of the gutsiest market calls in recent memory: That pretty much every asset class, everywhere, is in the midst of a bubble. It would be comforting if we could dismiss such negativity. After all, isn't the Dow Jones Industrial Average climbing to all time highs at a time when Japan and Europe are growing, China, India and much of the rest of Asia boom and all's well in the global financial system? Sure, and that's just what worries Grantham. He points to the U.S. in the late 1990s and Japan in the late 1980s -- periods when investors thought asset rallies would continue indefinitely. ``Most bubbles, like Internet stocks and Japanese land, go through an exponential phase before breaking, usually short in time, but dramatic in extent,'' Grantham argues, and he has a point. Bubbles generally require two dynamics: the perception of near-perfect economic conditions and an abundance of cheap credit… The trouble, Grantham says, is that the bursting of this bubble ``will be across all countries and all assets, with the probable exception of high-grade bonds. Risk premiums in particular will widen. Since no similar global event has occurred before, the stresses to the system are likely to be unexpected.''”

Hedge Fund Risk Concentrations Rising as Volatility Falls
From Market News International: “Research at the New York Federal Reserve Bank has found that concentrations of risk in the hedge fund industry, as measured by high correlations of hedge fund returns, is approaching the levels that prevailed before the 1998 collapse of Long-Term Capital Management (LTCM). However, the New York Fed research paper found a key difference between now and 1998: current high correlations of returns in the $1.5 trillion hedge fund industry mainly reflect a decline in the volatility of returns. The implication is that risk concentrations are not necessarily leading up to an LTCM-type collapse. That hedge fund's implosion, which accompanied a debt default and devaluation by Russia, aggravated a global liquidity crisis which prompted the Fed to make emergency interest rate cuts… "The correlation of hedge fund returns rose both in the period prior to the LTCM crisis and in recent times -- but for different reasons," he says. "An increase in the comovement of dollar returns was the leading cause of rising correlation in the 1990s, but a decline in overall volatility explains
the recent rise." Adrian finds that "high correlations of returns generally do not precede increases in volatility in the hedge fund sector, but high covariances among hedge funds do."… "This result suggests that comovement measured in dollars -- covariance -- is a more relevant indicator of risk than comovement measured in correlation, that is, covariance normalized by volatility," he writes. Adrian observes that "recently, hedge fund covariance has increased, but it is not at particularly high levels by historical
standards." Rather, he adds, "the unusually high correlation among hedge funds in the current environment is therefore attributable primarily to low hedge fund volatility -- a reflection of the generally low volatility of financial assets.”

Rating Agencies Voice Concerns about CMBS
From The New York Times: “Spurred by the collapse of the subprime mortgage market, the leading bond rating agencies are beginning to crack down on what they see as risky lending practices in commercial real estate. Low interest rates and an abundance of investment capital have led to heady times for buyers and sellers of office buildings, hotels and other income-producing property. Buildings have traded at record prices and loan terms have become increasingly generous, with many buyers putting little or no equity into the deals. Like residential loans, commercial mortgages are pooled and packaged into bonds that are sliced up into portions carrying different degrees of risk.

Global Manufacturing at a Seven Month High as Input Prices Rise Rapidly
From JP Morgan: “The JPMorgan global manufacturing PMI rebounded to 54.1 in April, the highest level since September 2006. The move was broadly based, with the indexes of output, employment, and new orders all moving up smartly. At the same time, the index of raw materials and work in progress inventory was little changed and remained below the 50 mark. The index of input prices moved sharply higher, reflecting recent strength in global commodity prices. The combination of rising new orders and lower inventories produced a big move up in the PMI ratio of new orders to inventory. We consider this ratio to be the best barometer of near-term momentum in the global manufacturing sector, and the move up to 1.12 in April—if it is sustained—would be a strong signal that the pace of manufacturing activity is poised to accelerate into midyear.”


MISC
From Dow Jones: “Treasury prices were modestly lower… The dollar was modestly higher… U.S. stocks rallied early on Wednesday, lifting the Dow Jones Industrial Average by over 100 points to a record high… Crude oil futures extended their losses…”

From Lehman: “Challenger announced layoffs jumped to 70,672 in April on the back of a surge in layoffs related to the subprime fallout. Financial sector layoffs were 33,789, accounting for almost 48% of total layoffs announced during the month. No other industry reported layoffs of more than 6,000. Hiring intentions picked up modestly, led by government hiring, which expected to hire 15,000 and accounted for two-thirds of the announced hiring intentions.”

From Merrill Lynch: “If you're looking for "global liquidity", don't look at Japan: the monetary base contracted 12.2% y/y in April, the 14th consecutive month of decline.”

From The Wall Street Journal: “If U.S. consumer spending now slows, the flow of dollars overseas should slow as well, potentially staunching foreign demand for Treasuries. What’s more, many countries may have concluded that they have enough Treasuries to tap into in times of trouble…Maybe that’s a reason why yields on 10-year Treasuries, at 4.64%, haven’t fallen much even though economic growth has slowed in the past year.” [Note WSJ spelled Treasuries and Treasurys]

From Merrill Lynch: “…the consumers' resilience is going to be severely tested in coming months from 4 sources: further declines in housing wealth as home prices adjust lower; receding employment growth as the pace of job creation follows the slowing in capex growth over the past year; more stringent credit standards going forward; and rising gasoline prices.”

From Merrill Lynch: “The export sector has to expand 10% for every 1% the consumer slows down just to prevent overall GDP growth from decelerating.”