Unsafe at Any Rating, CDO Speeds to CCC From AAA: Mark Gilbert

Aug. 30 (Bloomberg) -- Watching the rating cuts trickle out of the derivatives forest is akin to searching for elephant dung on a path to try and work out how many pachyderms are in the jungle. There's clearly a herd in there. And it's probably much bigger than the ordure you have seen so far would suggest.

Last week, Standard & Poor's butchered the ratings on $3.2 billion of debt from structured investment vehicles spawned by Solent Capital Partners LLP in London and Avendis Group in Geneva. About $254 million was slashed from the top AAA grade to CCC+ and CCC -- slides of 16 and 17 levels, triggered by their investments in mortgage-backed bonds.

Think about that for a second. You left the office Tuesday owning a AAA rated security. By the time you got back to your desk on Wednesday morning, it was eight steps below investment grade in a category S&P defines as ``currently vulnerable to nonpayment.'' Try explaining that to your pension-fund trustees.

The rating companies are sifting through the billions of dollars of repackaged bonds and structured investment funds they graded in recent years. You can bet the world's biggest and smallest banks are also panning for risk in the structured investment vehicles and off-balance-sheet companies they casually sponsored in the gold rush.

DBS Group Holdings Ltd., Singapore's biggest bank, said on Aug. 7 it had S$1.4 billion ($921 million) at stake in collateralized-debt obligations. This week, it boosted that total to S$2.4 billion. It seems the bank had overlooked its commitment to a unit called Red Orchid Secured Assets. As the man said, a billion here and a billion there and pretty soon you're talking about real money.

`An Oasis of Calm'

A rare moment of comedy arises from what Moody's Investors Service had to say about the oversight. ``I don't think DBS will be the only one who has missed something the first time,'' said Deborah Schuler, a senior Moody's analyst in Singapore.

Could this be the same Moody's that called structured investment vehicles ``an oasis of calm in the subprime maelstrom'' in a July 23 report? ``The vehicles are not structured to forcibly liquidate assets in times of crisis,'' Moody's said. Their ability to access several sources of finance ``obviates the need to liquidate large buckets of assets at potentially the worst period in the life of the vehicle.''

Tell that to Cheyne Capital Management Ltd., which said yesterday it may be forced to dump the securities owned by its $6 billion Cheyne Finance LLC fund because the asset-backed commercial paper market is freezing up and the SIV is struggling to fund itself beyond November.

Shifting Scenarios

Moody's recently added some new phrases to its lexicon of code words. When the rating company refers to ``updating its methodology'' or ``refining its risk assessments,'' what it really means is that its historical models say absolutely nothing about how the future might turn out.

Last week, for example, Moody's summarized ``the most recent refinements'' to how it treats bonds backed by so-called Alternative-A mortgages. ``In aggregate, the change in our loss estimates is projected to range from an increase of approximately 10 percent for strong Alt-A pools to an increase of more than 100 percent for weak Alt-A pools,'' Moody's said.

So a mortgage-backed security with a rating based on, say, a 1.5 percent loss rate might now suffer 3 percent losses in its collateral, Moody's said. How's that for missing something the first time?

Marked to Which Market?

Here's what is most worrying about the coming flood of downgrades and defaults. The U.S. Securities and Exchange Commission is investigating how the biggest brokerage firms priced securities caught up in the subprime meltdown as their values collapsed. My colleague Jonathan Weil last week detailed some of the accounting shenanigans that accompany how banks measure the ``fair value'' of their assets.

What happens if the SEC discovers that different units of a single bank assign different values to identical securities? That seems like a viable scenario for what might happen when a complex market of infrequently traded securities whose prices are dependent on a series of assumptions hits trouble.

And what happens if the SEC finds that banks marked the securities they owned at high prices, while attributing much lower values to identical securities offered by their hedge-fund clients as collateral? Again, that seems like a plausible strategy for a bank concerned about the longevity and liquidity of its customers.

Moving the Goalposts

Suppose regulators decide to play hardball on how the financial community marks to market, imposing rules that outlaw the existing freewheeling approach to how over-the-counter derivatives are assayed.

Moreover, suppose those new decrees come just as much of the underlying collateral is so tarnished as to be almost worthless compared with its initial valuation.

The ensuing carnage in the balance sheets of every financial-services company in the world would dwarf the damage wrought in the securities industry by the subprime crisis so far.

It will be hard enough for central bankers in the U.S. and Europe to set monetary policy at next month's meetings when they have no way of knowing how bad the financial storm might get and how much it might hurt economic growth. The more things that go boom in financial markets in the coming weeks, the harder the task facing the rate setters will get.

Fed injects $5bn of emergency reserves

By Eoin Callan in Washington

Published: August 30 2007 14:26 | Last updated: August 30 2007 14:26

The Federal Reserve said on Thursday it had injected $5bn of emergency reserves into the financial system after the overnight lending rate to banks climbed above the central bank’s target rate.

The Fed extended the 14-day loans in return for collateral that included $1.85bn of mortgage-backed securities, which have triggered the recent seizures in global credit markets.

The intervention shows that banks and institutions continue to lean on special contingency measures put in place by the central bank to improve liquidity.

Investors continue to bet that the Fed will cut its main interest rate when policymakers meet formally on September 18 following a steady stream of confidence-building measures in the last two weeks.

The Fed issued an ad hoc statement at the height of the credit crunch in mid-August that it detected an appreciable increase in risks to growth and was prepared to act to avoid adverse consequences for the US economy.

Fed Chairman Ben Bernanke is expected to reiterate this message when he addresses a gathering of central bankers in Jackson Hole, Wyoming, on Friday.

Government figures showed that the economy entered the turbulent third quarter on a stronger note than initially thought.

Gross domestic product grew by an annual rate of 4 per cent in the second quarter as business investment helped offset a deteriorating housing sector.

Economists, however said this pace of growth was unlikely to be sustained has tighter lending conditions began to squeeze business expenditure. The Fed has also recently pared back its internal growth forecasts for this year and next.

The growth estimate was in line with Wall Street economists’ forecasts and outstripped the first quarter’s anaemic 0.6 per cent rate of expansion.

Inflation in core prices – excluding food and energy costs – cooled to a rate of 1.3 per cent from 2.4 per cent in the first quarter, the lowest since the second quarter of 2003.

Idaho senator's future in question after arrest on sex-related charge

By Matthew Daly

ASSOCIATED PRESS

5:01 a.m. August 28, 2007

WASHINGTON – Idaho Sen. Larry Craig, who has voted against gay marriage and opposes extending special protections to gay and lesbian crime victims, finds his political future in doubt after pleading guilty to misdemeanor charges stemming from complaints of lewd conduct in a men's room.

The conservative three-term senator, who has represented Idaho in Congress for more than a quarter-century, is up for re-election next year. He hasn't said if he will run for a fourth term in 2008 and was expected to announce his plans this fall.

A spokesman, Sidney Smith, was uncertain late Monday if Craig's guilty plea in connection with an incident at the Minneapolis airport would affect his re-election plans.

“It's too early to talk about anything about that,” Smith said.

A political science professor in Idaho said Craig's political future was in jeopardy. And a spokesman for the Democratic Senate Campaign Committee, Hannah August, said Craig's guilty plea “has given Americans another reason not to vote Republican” next year.

The married Craig, 62, has faced rumors about his sexuality since the 1980s, but allegations that he has engaged in gay sex have never been substantiated. Craig has denied the assertions, which he calls ridiculous.

The arrest changes that dynamic, said Jasper LiCalzi, a political science professor at Albertson College of Idaho in Caldwell, Idaho. He cited the House page scandal that drove Florida Rep. Mark Foley from office.

“There's a chance that he'll resign over this,” LiCalzi said. “With the pressure on the Republican Party, he could be pressured to resign. If they think this is going to be something that's the same as Mark Foley – the sort of 'drip, drip, drip, there's more information that's going to come out' – they may try to push him out.”

Already Craig has stepped down from a prominent role with Mitt Romney's presidential campaign. He had been one of Romney's top Senate supporters, serving as a Senate liaison for the campaign since February.

“He did not want to be a distraction and we accept his decision,” said Matt Rhoades, a Romney campaign spokesman.

According to a Hennepin County, Minn., court docket, Craig pleaded guilty to a disorderly conduct charge on Aug. 8, with the court dismissing a charge of gross misdemeanor interference to privacy.

The court docket said Craig paid $575 in fines and fees and was put on unsupervised probation for a year. A sentence of 10 days in the county workhouse was stayed.

Roll Call, a Capitol Hill newspaper, which first reported the case, said on its Web site Monday that Craig was arrested June 11 by a plainclothes officer investigating complaints of lewd conduct in a men's restroom at the airport.

Minneapolis airport police declined to provide a copy of the arrest report after business hours Monday.

Roll Call, citing the report, said Sgt. Dave Karsnia made the arrest after an encounter in which he was seated in a stall next to a stall occupied by Craig. Karsnia described Craig tapping his foot, which Karsnia said he “recognized as a signal used by persons wishing to engage in lewd conduct.”

Roll Call quoted the Aug. 8 police report as saying that Craig had handed the arresting officer a business card that identified him as a member of the Senate.

“What do you think about that?” Craig is alleged to have said, according to the report.

Craig said in a statement issued by his office Monday that he was not involved in any inappropriate conduct.

“At the time of this incident, I complained to the police that they were misconstruing my actions,” he said. “I should have had the advice of counsel in resolving this matter. In hindsight, I should not have pled guilty. I was trying to handle this matter myself quickly and expeditiously.”

Craig joins other GOP senators facing ethical and legal troubles.

Sen. Ted Stevens, R-Alaska, is under scrutiny for his relationship with a contractor who helped oversee a renovation project that more than doubled the size of the senator's home.

Sen. David Vitter, R-La., acknowledged that his phone number appeared in records of a Washington-area business that prosecutors have said was a front for prostitution.

Craig, a rancher and a member of the National Rifle Association, lives in Eagle, Idaho, near the capital of Boise. He was a member of the House for 10 years before winning election to the Senate in 1990. He was re-elected in 1996 and 2002.

Last fall, Craig called allegations from a gay-rights activist that he's had homosexual relationships “completely ridiculous.”

Mike Rogers, who bills himself as a gay activist blogger, published the allegations on his Web site, www.blogactive.com, in October 2006.

Matt Foreman, executive director of the National Gay and Lesbian Task Force, an advocacy group, on Monday called Craig a hypocrite.

“What's up with elected officials like Senator Craig? They stand for so-called family values and fight basic protections for gay people while furtively seeking other men for sex,” Foreman said.

Fed bends rules to help two big banks

If the Federal Reserve is waiving a fundamental principle in banking regulation, the credit crunch must still be sapping the strength of America's biggest banks. Fortune's Peter Eavis documents an unusual Fed move.

By Peter Eavis, Fortune writer

August 24 2007: 5:09 PM EDT

NEW YORK (Fortune) -- In a clear sign that the credit crunch is still affecting the nation's largest financial institutions, the Federal Reserve agreed this week to bend key banking regulations to help out Citigroup (Charts, Fortune 500) and Bank of America (Charts, Fortune 500), according to documents posted Friday on the Fed's web site.

The Aug. 20 letters from the Fed to Citigroup and Bank of America state that the Fed, which regulates large parts of the U.S. financial system, has agreed to exempt both banks from rules that effectively limit the amount of lending that their federally-insured banks can do with their brokerage affiliates. The exemption, which is temporary, means, for example, that Citigroup's Citibank entity can substantially increase funding to Citigroup Global Markets, its brokerage subsidiary. Citigroup and Bank of America requested the exemptions, according to the letters, to provide liquidity to those holding mortgage loans, mortgage-backed securities, and other securities.

This unusual move by the Fed shows that the largest Wall Street firms are continuing to have problems funding operations during the current market difficulties, according to banking industry skeptics. The Fed's move appears to support the view that even the biggest brokerages have been caught off guard by the credit crunch and don't have financing to deal with the resulting dislocation in the markets. The opposing, less negative view is that the Fed has taken this step merely to increase the speed with which the funds recently borrowed at the Fed's discount window can flow through to the bond markets, where the mortgage mess has caused a drying up of liquidity.

On Wednesday, Citibank and Bank of America said that they and two other banks accessed $500 million in 30-day financing at the discount window. A Citigroup spokesperson declined to comment. Bank of America dismissed the notion that Banc of America Securities is not well positioned to fund operations without help from the federally insured bank. "This is just a technicality to allow us to use our regular channels of business with funds from the Fed's discount window," says Bob Stickler, spokesperson for Bank of America. "We have no current plans to use the discount window beyond the $500 million announced earlier this week."

There is a good chance that other large banks, like J.P. Morgan (Charts, Fortune 500), have been granted similar exemptions. The Federal Reserve and J.P. Morgan didn't immediately comment.

The regulations in question effectively limit a bank's funding exposure to an affiliate to 10% of the bank's capital. But the Fed has allowed Citibank and Bank of America to blow through that level. Citigroup and Bank of America are able to lend up to $25 billion apiece under this exemption, according to the Fed. If Citibank used the full amount, "that represents about 30% of Citibank's total regulatory capital, which is no small exemption," says Charlie Peabody, banks analyst at Portales Partners.

The Fed says that it made the exemption in the public interest, because it allows Citibank to get liquidity to the brokerage in "the most rapid and cost-effective manner possible."

So, how serious is this rule-bending? Very. One of the central tenets of banking regulation is that banks with federally insured deposits should never be over-exposed to brokerage subsidiaries; indeed, for decades financial institutions were legally required to keep the two units completely separate. This move by the Fed eats away at the principle.

Sure, the temporary nature of the move makes it look slightly less serious, but the Fed didn't give a date in the letter for when this exemption will end. In addition, the sheer size of the potential lending capacity at Citigroup and Bank of America - $25 billion each - is a cause for unease.

Indeed, this move to exempt Citigroup casts a whole new light on the discount window borrowing that was revealed earlier this week. At the time, the gloss put on the discount window advances was that they were orderly and almost symbolic in nature. But if that were the case, why the need to use these exemptions to rush the funds to the brokerages?

Expect the discount window borrowings to become a key part of the Fed's recovery strategy for the financial system. The Fed's exemption will almost certainly force its regulatory arm to sharpen its oversight of banks' balance sheets, which means banks will almost certainly have to mark down asset values to appropriate levels a lot faster now. That's because there is no way that the Fed is going to allow easier funding to lead to a further propping up of asset prices.

Don't forget: The Federal Reserve is in crisis management at the moment. However, it doesn't want to show any signs of panic. That means no rushed cuts in interest rates. It also means that it wants banks to quickly take the big charges that will inevitably come from holding toxic debt securities. And it will do all it can behind the scenes to work with the banks to help them get through this upheaval. But waiving one of the most important banking regulations can only add nervousness to the market. And that's what the Fed did Monday in these disturbing letters to the nation's two largest banks.

Housing crisis -- no end in sight

Economy was good, danger signs were ignored. Then came the cliff.

By Dale Kasler - Bee Staff Writers
Published 12:00 am PDT Sunday, August 26, 2007

Summoned to the Legislature in late January for a hearing on subprime mortgage lending, Marc Lowenthal struck a confident tone.

Lowenthal, a senior executive at Irvine subprime lender New Century Financial Corp., told lawmakers that the industry was in solid shape -- and an asset to the nation. Clamping down on subprime loans would only bring "severe, negative consequences for consumers, the real estate market and the economy," he said.

Outside the Capitol, in the neighborhoods of Sacramento and beyond, mortgage defaults were already climbing. But New Century was still all pedal and no brakes. Loan volume remained brisk, and the company seemed headed for another blockbuster year.

Just a couple of weeks later, New Century was essentially kaput, done in by runaway loan defaults and a panic among investors. Its shocking demise marked the start of a crisis in the mortgage industry that has rattled Wall Street and raised fears of a recession.

In a sense, New Century and other fallen lenders -- as well as homeowners who are losing their properties -- are victims of history. Until now, most experts say, the housing market had never undergone a serious swoon as long as the economy was still growing. Lenders took comfort in the argument that only a recession could do major harm to the housing sector and ignored signs that the market was going cold.

"The hubris of the period was driven ... by the thought that the economy was on sound footing," said Mark Zandi, chief economist at national consulting firm Moody's Economy.com. "That argument convinced the homebuilders and the lenders and added to the frenzy."

Zandi and others say the slump's peculiar nature contributed to the severity of the problem. The absence of a recession kept lenders running nearly full tilt until it was too late.

The total volume of subprime loans nationally fell less than 4 percent in 2006, even as defaults and foreclosures were starting to spike, according to data compiled by Credit Suisse. Some big lenders never really did apply the brakes: New Century's loan volume was down a mere 1.3 percent through the end of February, or about two weeks before trading in the company's stock was suspended.

"The mentality was ... the economy's great and everything's fine," said Chris Thornberg, head of Beacon Economics consulting firm in Los Angeles. "That was the mentality that to some extent drove these excesses."

For now, unemployment remains relatively low. But the lack of historical precedent has lent an ominous feel to the housing slump, making it harder to predict what the impact will be on the overall economy.

"We haven't faced this before," said Howard Roth, chief economist at the state Department of Finance. "It may well be a new phenomenon that we're seeing -- a downturn in the housing sector slowing down the overall economy."

Mortgage specialist Heather Fern-Luzzi, with two decades of experience in the business, thought she'd seen it all. But this downturn, which just claimed her job, has her baffled.

"There's nothing to compare it to," said Fern-Luzzi, the Roseville branch manager of recently collapsed mortgage lender First Magnus Financial Corp.

"I've seen it since the 1980s -- I've been in downward markets and there's always been the light at the end of the tunnel," she said as she packed files for shipment to First Magnus' headquarters in Arizona. "This one seems to be different."

This year several hundred people in the capital region mortgage industry already have found themselves out of jobs. Many are having to go outside their industry for work or to switch careers.

"They might have to look at other areas of finance," said David Lyons, labor market consultant at the state Employment Development Department. "There are probably opportunities in the commercial and industrial side. They'll want to look at their skills and other industries that may be growing. They're out there. They just have to do a little job searching."

The ongoing rash of foreclosures has spooked potential homebuyers even though the job market is in decent shape, said veteran Sacramento real estate agent Leigh Rutledge. The dark cloud won't lift soon.

"We've just got a long ways to go with all this subprime stuff," she said.

The last great housing downturn in California, begun in the early 1990s, followed a more recognizable pattern. The end of the Cold War clobbered California's aerospace and military sectors, causing massive layoffs.

In Sacramento, all three military bases ultimately closed, and unemployment topped 9 percent. Skilled construction workers deserted Sacramento for cities like Phoenix and Las Vegas. No wonder home prices went into a tailspin that lasted eight years.

This time, housing experienced a once-in-a-lifetime boom caused by excessively loose lending standards. Interest-only loans and other exotic products made homeowners out of millions with iffy credit histories. The exploding secondary market -- made up of institutional investors, many of them from overseas, willing to purchase those loans -- provided the fuel.

"Globalization had a lot to do with this," said Greg Sandler, founder of Roseville-based 1st National Home Loans. "Essentially, we're not playing with the same road map here. This is a different downturn than ever before."

Loose loans have made the collapse unusually swift. Defaults and foreclosures have increased at a much faster pace than in previous slumps. In the 1990s, even with unemployment soaring, it took five years for defaults in Sacramento County to double, according to DataQuick Information Systems. This time, the default volume has more than tripled in a little over a year. Defaults are the first step toward foreclosure.

"It's more severe now; it's much faster," said Michael Carney, a professor of finance and real estate at California State Polytechnic University, Pomona, and director of the nonprofit Real Estate Research Council.

The meltdown in the mortgage business could take the economy into a recession, said Stuart Gabriel, director of the Ziman Center for Real Estate at UCLA.

"This credit crunch is terribly exacerbating the downturn in housing," he said. "The longer this credit crunch persists, and the wider the implications, the more likely we will have a general economic downturn."

Unemployment has edged up to 5.3 percent statewide. But that's well below the 6.9 percent recorded in 2003, during the last economic downturn, or the 9.9 percent in 1992, the peak of the 1990s recession.

The current slowdown has been offset by strength in commercial and industrial construction. State government is hiring again, a boost for Sacramento.

"Fundamentally, I think we have good job growth in other sectors," said EDD's Lyons.

Richard Brown, chief economist at the Federal Deposit Insurance Corp., said he believes a recession can be avoided. "I would say the economic fundamentals ultimately win out," he said.

But with housing clearly stressing the economy, there's cause for concern. Many believe the housing market won't improve until late 2008, at the earliest. The slump is hurting retailers, particularly home-improvement chains. Car sales are affected, too, as consumers are less apt to borrow against their home equity to make big purchases.

"First, we had construction, then financing, now furniture," said economist G.U. Krueger of Institutional Housing Partners, an investment firm in Irvine. "It's now spreading into the broader segments of the economy.

"We're still fortunate that the part of the economy that has nothing to do with real estate is still relatively strong. We're lucky the consumer (spending) is holding up as much as it has. We're lucky the jobs are holding up as much as they are. That's, of course, the thing to watch."

Glut of homes hits 16-year high

Sales slip but supply of homes on the market jumps to 9.6 months, pushing prices down for 12th straight month.

By Chris Isidore, CNNMoney.com senior writer
August 27 2007: 3:12 PM EDT

NEW YORK (CNNMoney.com) -- Homeowners trying to sell last month faced the biggest glut of homes on the market in about 16 years, as declining sales and growing problems in the mortgage market helped push home prices down for the 12th straight month.

The National Association of Realtors said sales by homeowners slipped to an annual rate of 5.75 million last month, down 0.2 percent from the revised 5.76 million pace in June. Economists surveyed by Briefing.com had forecast the sales rate would fall to 5.7 million in the latest reading.

Not only did sales slip but the number of homes for sale jumped 5.1 percent, the group said, meaning there is now a 9.6-month supply of homes for sale, up from 9.1-months in the June reading. It was the biggest supply of homes by that measure since October 1991.

"Forget 'location, location, location.' The most important factor in today's real estate market is 'supply, supply, supply,'" said Mike Larson, a real estate analyst at with independent research firm Weiss Research.

"We are literally swimming in an ocean of homes for sale. In fact, at 4.59 million units, we have the most raw inventory for sale in history," he said. "Until we work through this extremely large inventory glut, we're not going to see any momentum in home prices."

Even the Realtors' own economist admitted that problems in the mortgage market will continue to take a toll on home sales.

"Home sales probably would be rising in the absence of the mortgage liquidity issues of the past two months," said Lawrence Yun, the trade group's senior economist.

"Some buyers with contracts have been scrambling when loan commitments did not materialize at the last moment, while other potential buyers are simply waiting for the mortgage market to stabilize."

August has seen problems in the mortgage market cut deeply into the availability of financing for many buyers, particularly those needing subprime mortgages due to credit rating issues or a jumbo mortgage of more than $417,000.

The existing home sale numbers track sales that closed in the month. Closings typically occur a month or two after buyers lock in financing.

"These are 'PC' figures -- pre-crunch," said Larson. "The mortgage credit crunch that began very late in July and picked up steam in August will likely put more downward pressure on home sales and prices this month and into the fall."

The report comes after Friday's government reading that showed new homes selling at a better-than-expected pace. But the reports showed more weakness in prices - which have become a major concern for the U.S. economy as a whole.

The median price of an existing home sold in the month fell 0.6 percent from a year earlier to $228,900. It marked the 12th straight month that prices have been down on that basis, after the June reading was revised lower as well. The July 2006 median price was a record high for that reading, which measures the point at which half the homes sold go for more and half go for less.

Experts have tied weak auto sales at least partly to concerns among consumers about the decline in equity in their homes. Some fear that weakness in home values and reduced access to home equity lines of credit could soon affect a broader range of retail sales.

In addition, the downturn in housing has also fed investor concern about mortgage-backed securities, which in turn has created a credit crunch in financial markets, and sent stocks into a tailspin, as a number of corporate deals have run into financing problems.

Not surprisingly, results at the nation's home builders have been among the hardest hit.

While luxury home builder Toll Brothers (Charts, Fortune 500) managed to report a narrow profit last week that topped forecasts of a loss, it still saw earnings fall 85 percent from year-earlier levels. And the six publicly traded builders who are larger than Toll have all reported losses recently.

Lennar (Charts, Fortune 500), the nation's No. 1 builder, and No. 5 KB Home (Charts, Fortune 500) both reported a loss in the latest quarter. No. 2 home builder D.R. Horton (Charts, Fortune 500) and No. 3 Centex (Charts, Fortune 500) both reported losses far bigger than Wall Street had expected, while No. 6 Pulte Homes (Charts, Fortune 500) and Hovnanian Enterprises (Charts, Fortune 500) have reported losses for the last two quarters and analysts project losses for at least the next year.

Blood Bath

The Dow Jones Newswires report on Florida.

“One Bal Harbour may look like just another sign of excess in Miami’s oversaturated condo market, but to developer WCI Communities the luxury tower represents crucial cash. WCI launched the project during the housing boom, when developers rushed to fill what seemed to be an insatiable demand for housing, particularly condominiums.”

“In the time it took to earn approvals for and build the condos, the housing bubble popped. That has left Florida awash in a record number of condos. South Florida alone has about 65,000 listed for sale.”

“There’s been an 80% drop in new condo sales in the last year and tens of thousands of more units should flood the market in the next 24 months, leaving ‘many years’ worth of inventory,’ according to broker Mike Morgan. ‘From here on out, it’s just all downhill,’ he said.”

“Warned Alex Barron, an analyst with Agency Trading Group: ‘It’s going to be a bloodbath.’”

“Industry watchers wonder if the building, which has already been delayed, will actually open on time. After touring One Bal Harbour Saturday, Morgan said a lot of work remains. ‘I did not see enough activity to demonstrate they are even trying to hit a September closing,’ he wrote in an email to clients. ‘With the overall market imploding, this is not a good sign for WCI.’”

Mortgage Job Losses Surpass 40,000

Wednesday August 22, 6:35 pm ET
By Ieva M. Augstums, AP Business Writer As Mortgage Industry Retrenches, Industry Job Cuts Surpass 40,000 CHARLOTTE, N.C. (AP) -- At the North Carolina offices of mortgage lender HomeBanc Corp., Archie Clark is the only employee left. But in a few days, he'll be gone, too. When Clark finishes helping movers from the company's Atlanta headquarters collect computers and other property, he'll join the more than 25,000 workers nationwide who have lost jobs in the financial services industry since the beginning of the month -- with more than half coming since last Friday.

With few exceptions, the cuts are the direct result of woes in the nation's housing market.

More layoffs are announced daily. On Wednesday, Lehman Brothers Holdings Inc. closed its "subprime" mortgage business, laying off 1,200 workers at 23 offices; Scottsdale, Ariz.-based 1st National Bank Holding Co. closed its wholesale mortgage unit and cut 541 jobs, and Accredited Home Lenders Holding Co. added 1,600 positions to the heap. The night before, banking giant HSBC said it would close a main financing office and cut 600 jobs.

Since the start of the year, more than 40,000 workers have lost their jobs at mortgage lending institutions, according to recent company layoff announcements and data complied by global outplacement firm Challenger, Gray & Christmas Inc. Meanwhile, construction companies have announced nearly 20,000 job cuts this year, while the National Association of Realtors expects membership rolls to decline this year for the first time in a decade.

It's an employment collapse that threatens to rival the massive layoffs in the airline industry that followed the Sept. 11, 2001, terrorist attacks, when some 100,000 employees lost their jobs.

"It's far from over," said Bart Narter, a senior analyst with Celent, a Boston-based financial research and consulting firm. "The subprime lending collapse will continue to ripple through the financial sector."

"These kind of mortgage lenders just sprung up like mushrooms and grew like men," said John A. Challenger, chief executive at Challenger, Gray & Christmas. "They staffed up and now you have a bust."

America's largest mortgage lender, Countrywide Financial Corp., began an undisclosed number of layoffs this week. Last week, Arizona mortgage lender First Magnus Financial Corp. shut down its operations and laid off nearly 6,000 workers. On Monday, Capital One Financial Corp. said it would shutter Greenpoint Mortgage, its wholesale mortgage banking business, and lay off 1,900 employees.

"It's only been weeks," Challenger said. "These companies are acting remarkably quickly, stopping on a dime."

Andy Roach didn't foresee the turmoil when he joined Greenpoint in March. As late as June, the 25-year industry veteran thought the business of making "Alternative A" mortgage loans -- geared for those with slightly better credit than subprime borrowers -- was on a solid track.

But in July, he said, spooked investors stopped buying the securities the company sold by repackaging the loans. A little more than a month later, Capital One announced that Roach and about 1,900 of his colleagues across the country were out of a job.

"It was evident that it was serious," said Roach, 46, a regional manager in the Chicago suburb of Downers Grove. "When you can't sell the loans, when there's no market for those loans, it put us in a bad, bad situation."

Clark, 33, headed information technology operations for three HomeBanc offices in the Raleigh area. He had a feeling earlier this month that trouble was lurking, as the company began cutting back on perks and made some initial layoffs. On Aug. 9, HomeBanc filed for bankruptcy protection. They kept him on through the end of the month to collect equipment and "just go in and check on things."

"It was pretty much a free for all in the office, people taking paper, stuff HomeBanc wouldn't need," he said. "I don't feel like HomeBanc did anything. It was a perfect storm of a bad housing market."

Two of Clark's friends have already landed jobs with Countrywide. Another found work with an affiliate of First Magnus, and was almost immediately laid off again. Roach plans to open his own lending business, focusing on commercial business loans and originating home loans himself.

"The mortgage business isn't dead -- there's just going to be less people in it," Roach said.

Associated Press writers Mike Baker and Margaret Lillard in Raleigh, N.C., contributed to this report.

Financial job cuts soar on housing woes

Tuesday August 21, 3:34 pm ET

By Jonathan Stempel NEW YORK (Reuters) - A deepening U.S. housing slump has caused an alarming surge in job losses at U.S. financial services companies, and the end is nowhere in sight, consulting firm Challenger, Gray & Christmas Inc. said on Tuesday.

The industry has announced 87,962 job cuts so far this year, 75 percent more than the 50,327 recorded for all of 2006, Challenger said. Nearly one-fourth of this year's cuts have been announced in August alone.

Of this year's cuts, 35,830, or 41 percent, were tied to housing market troubles, including riskier subprime mortgages. Job cuts by real estate and construction firms totaled 21,620, more than twice the number for all of 2006, Challenger said.

"Many companies expected the mortgage situation to implode; they've just been wondering when the bubble would burst," Chief Executive John Challenger said in an interview. "But many are stopping on a dime, shutting down operations.

"Companies are not surprised by what's happening, but the reality of the situation and the speed with which it occurred is shocking," Challenger added. He said it could be months before housing-related job cuts peak.

In the last week, investment bank Bear Stearns Cos, credit card issuer Capital One Financial Corp and mortgage lenders Countrywide Financial Corp and First Magnus Financial Corp announced 8,640 mortgage-related job cuts, Challenger said.

Another 2,400 cuts were announced by SunTrust Banks Inc as part of the bank's existing cost-cutting program.

Many companies exposed to the housing market have struggled with rising delinquencies and foreclosures as mortgage rates have reset higher and housing price appreciation has slowed.

Meanwhile, credit conditions have tightened as investors have grown unwilling to buy home loans once thought safe, starving many lenders of cash they need to operate normally. Dozens of mortgage lenders have quit the industry this year.

April has been the year's busiest month for financial job cuts, Challenger said. That month, companies announced 33,789 cuts, including 17,000 by Citigroup Inc and 3,200 by bankrupt mortgage lender New Century Financial Corp.

Job cuts are mounting as credit losses widen.

On Tuesday, the government's Office of Thrift Supervision said troubled assets, or loans at least 90 days past due, rose at savings and loans it regulates to $14.2 billion in the second quarter from $9.5 billion a year earlier.

Meanwhile, home foreclosure filings in July surged 93 percent from a year earlier and rose 9 percent from June, to 179,599, according to a Tuesday report by research firm RealtyTrac.

John Challenger said it's understandable for mortgage workers to feel whipsawed. Countrywide, for example, cut 500 jobs last week after having added 6,931 jobs from January to July, with increases in every calendar month.

"It's devastating (for morale)," he said. "It's hard to keep morale up, given the boom-bust nature of the mortgage sector."

(Additional reporting by John Poirier and Patrick Rucker in Washington, D.C.)

Foreclosures Up 93 Percent

Tuesday August 21, 3:22 pm ET
By Alex Veiga, AP Business Writer U.S. Home Foreclosures Jump Sharply in July, Up 9 Percent From June LOS ANGELES (AP) -- The number of foreclosure filings reported in the U.S. last month jumped 93 percent from July of 2006 and rose 9 percent from June, the latest sign that homeowners are having trouble making payments and finding buyers during the national housing downturn.

There were 179,599 foreclosure filings reported during July, up from 92,845 during the same period a year ago, Irvine-based RealtyTrac Inc. said Tuesday. There were 164,644 foreclosure filings reported in June.

The national foreclosure rate in July was one filing for every 693 households, the company said.

"While 43 states experienced year-over-year increases in foreclosure activity, just five states -- California, Florida, Michigan, Ohio and Georgia -- accounted for more than half of the nation's total foreclosure filings," RealtyTrac Chief Executive James J. Saccacio said.

The filings include default notices, auction sale notices and bank repossessions.

Some properties included in the survey might have received more than one notice, if the owners have multiple mortgages.

The company did break out individual properties as part of its report for the first six months of this year, when a total of 573,397 properties reported some sort of foreclosure activity.

That represents a 58 percent jump from the 363,672 properties in the first six months of 2006 and a 32 percent increase from the 433,504 in the last six months of 2006, the firm said.

In the July report, Nevada, Georgia and Michigan accounted for the highest foreclosure rates nationwide.

Nevada posted the highest foreclosure rate: one filing for every 199 households, or more than three times the national average. It reported 5,116 filings during the month, an increase of 8 percent from June.

Georgia's foreclosure rate was more than twice the national average, with one filing for every 299 households. The state reported 12,602 foreclosure filings, up 75 percent from June.

Michigan reported 13,979 filings in July, a 39 percent spike from June.

California, Florida and Ohio were among the states with the highest number of foreclosure filings in July, RealtyTrac said.

California cities continued to dominate top metropolitan foreclosure rates.

The state reported 39,013 foreclosure filings last month, the most by any single state. However, the number of filings rose less than 1 percent from June.

The state's foreclosure rate was one filing for every 333 households, RealtyTrac said.

Florida's foreclosure filings dropped 9 percent between June and July to 19,179. The July figure, however, represents a 78 percent jump from the year-ago period.

In recent months, the mortgage industry has been battered by rising defaults and foreclosures, primarily driven by borrowers with subprime loans and adjustable rate mortgages.

Lagging home sales and flat or decreasing home prices have made it more difficult for homeowners who fall behind on payments to sell their homes and clear the debt, spurring the rise in foreclosure activity.

Loan types seeing higher delinquencies and defaults in general are home equity loans or second mortgages used to cover a downpayment, subprime loans to people with shaky credit histories, and Alt-A loans, which can include interest-only and adjustable rate mortgages sold with little or no documentation.

Deflation Is Next

Rick Ackerman

The Times, the Journal, and other status quo purveyors of news must surely regard the mortgage crisis as something to be resolved in due time, presumably by an inevitable upswing in home prices and a little help from the central bank. But such thinking only confirms that they are as clueless now as they were when the real estate crisis reached critical mass nearly two years ago. And, we are certain, they will be equally clueless when the expected upswing in home prices fails to materialize and deflation tightens its death-grip on the U.S. and global economies.

By then, the praise and respect the news media have mindlessly heaped on former Fed Chairman Alan Greenspan will be under reconsideration. For the record, let us say that he has already been tried and convicted by the vast newsletter world as the main instigator of a credit blowout that could only have ended as this one is about to: in a global bust. Three generations after the start of the Great Depression, the eggheads, pundits and wonks are still looking for a culprit. Was it the Smoot-Hawley tariff? Too-tight credit after the market crashed? The next time around, when the saga of the Second Great Depression is told, they need look no further than a Federal Reserve that succeeded in turning the concept of “free lunch” into America’s one true mainstream religion.

Capital One to Shut Unit, Cut 1,900 Jobs

Monday August 20, 9:20 pm ET
By Mike Baker, Associated Press Writer Capital One to Cut 1,900 Jobs and Close Its Wholesale Mortgage Business

Capital One Financial Corp. said Monday it will cut 1,900 jobs and shutter its wholesale mortgage banking business, a move that comes as lenders continue to struggle in the nation's housing and mortgage markets.

Capital One said it will shut down GreenPoint Mortgage and eliminate most of the jobs by the end of year. The McLean, Va.-based company will close 31 GreenPoint locations in 19 states and "cease residential mortgage origination" effective immediately but said it will honor commitments to customers with locked rates who have loans already in the pipeline.

"Over the past few months, we have experienced an unprecedented disruption in the secondary mortgage markets," Capital One Chairman and Chief Executive Officer Richard D. Fairbank wrote in an internal memo to employees. "I made the decision to wind down the business with a heavy heart."

GreenPoint, based in Novato, Calif., specializes in no-documentation and Alt-A mortgage loans for borrowers with slightly better credit than subprime borrowers. In his memo, Fairbank said that market has seen a "significant reduction in liquidity and continuing volatility."

The decision to close GreenPoint will hit Capital One with an $860 million charge, or $2.15 per share, the vast majority of which will come in 2007. The company lowered its 2007 earnings guidance by 14 percent to $5 per share.

Analysts polled by Thomson Financial expected earnings of $7.05 per share. Analysts estimates typically exclude one-time charges.

Capital One made the announcement after markets closed Monday. Its shares fell $2.03 to close at $66.72, then fell 15 cents in after-hours trading.

Bart Narter, a senior analyst with Celent, a Boston-based financial research and consulting firm, said GreenPoint's model of processing, packaging and selling loans to investors didn't mix well with Capital One's historical strengths.

"Capital One was smart to say, 'We shouldn't be in this business,'" Narter said. "Capital One is in the business of understanding their customers well and keeping direct relationships with their customers. So I'm not surprised by their decision."

Capital One said its other business lines remain solid and in line with expectations, adding that it will continue to sell home loans through Capital One Home Loans and its bank branches.

"Capital One's other businesses are supported by ample liquidity and funding including deep access to deposits, a 'stockpile' of subordinated credit card funding in place that allows approximately $9 billion of AAA credit card funding going forward, and a $25 billion portfolio of highly liquid securities," said Gary Perlin, the company's chief financial officer.

As the nation's housing market has cooled, the mortgage lending industry has struggled with a dramatic rise in mortgage defaults and foreclosures. Many homebuyers have been forced into default or foreclosure because they haven't been able to sell their homes or end up owing more than their home is worth.

As a result, it has become more difficult for lenders like GreenPoint to sell the mortgages they originate to investors.

"The reductions in demand and pricing in the secondary mortgage markets make it difficult to operate our wholesale mortgage banking business profitably," Perlin said.

Once a stand-alone credit card company, Capital One has moved in the past two years to acquire traditional banks as part of an effort to diversify. In acquired GreenPoint in December as a part of a $13.2 billion purchase of North Fork Bancorp, which operates banks in New York, New Jersey and Connecticut.

Fairbank told employees Monday that he had expected GreenPoint's business to continue growing.

"Unfortunately, GreenPoint has run into unforeseen challenges that are beyond its control," Fairbank said.

Central banks are stealing from the average citizen

What happens when fiscal irresponsibility gets rewarded with bailouts? You get more fiscal irresponsibility. Let's stop rescuing greedy financiers and investors.

By Bill Fleckenstein

As regular readers know, I have been a longtime critic of the Federal Reserve. Not too far back, that view was a decidedly minority one.

But as our credit bubble undergoes an ugly unwinding, it's dawning on folks that central banks lie at the epicenter of the problem. Andy Xie nailed it in Tuesday's Financial Times, which is why I've chosen to begin my column with quotes from his article "It's time for central banks to stop bailing out markets."

The bailout stops here

He writes: "The global credit bubble is bursting. This bubble is primarily leverage financing for owning risky assets. The people who were responsible for what happened played with other people's money, marketed arcane financial products with false promises of fat profits, but stuffed their own pockets with big bonuses. Neither these masters of the universe nor their greedy but naive investors deserve to be bailed out. They deserve what is coming to them.

"The central banks should focus on price stability, not financial market stability, and should provide liquidity only to contain the multiplier effect of the bubble bursting on the economy. Nor should central banks stimulate to avoid recession at any cost. Business cycles are not bad. Excesses must be followed with cleansing. . . .

"Markets have been taking more risk than they should because they believe that central banks will come to their aid during times of crisis, like now. The penchant of Alan Greenspan, former U.S. Federal Reserve chairman, to flood the market with liquidity during financial instability is the genesis of this 'central bank put.' As long as this expectation remains, financial bubbles will occur again and again. Now is the time to act. Let the crooks go bankrupt. Central banks should bury the Greenspan 'put' for good."

All I can say is amen to that -- and hope this is how events turn out. Of course, given how central banks have behaved in the past decade, I'm not holding my breath. But perhaps this article in the Financial Times will help crystallize for them what it is they need to do. It's always possible that this time around, the central banks will let capitalism work. That could help hasten the cleansing process -- aka creative destruction -- which would be a positive development, for sure.

Illiquid versus insolvent

Similarly, folks should read what Nouriel Roubini says at RGE Monitor about the current crisis, because I think he hits the nail on the head.

Rather than being a liquidity crisis like the 1998 failure of Long-Term Capital Management -- which was more like a run on the bank and was stemmed by the powers that be -- Roubini describes the current situation as a "liquidity crisis that signals a more fundamental debt, credit and insolvency crisis among many economic agents in the U.S. and global economy."

For folks in a hurry, the last paragraph of Roubini's piece captures the essence of the problem. In the meantime, the last few lines nicely sum it up:

"We are indeed at a 'Minsky Moment' and this recent financial turmoil is the beginning of a much more serious and protracted U.S. and global credit crunch. The risks of a systemic crisis are rising: Liquidity injections and lender-of-last-resort bailout of insolvent borrowers -- however necessary and unavoidable during a liquidity panic -- will not work; they will only postpone and exacerbate the eventual and unavoidable insolvencies."

Video on MSN Money

The latest Fed cuts
The Fed cuts discount window rate by 50 basis points, with CNBC's Steve Liesman.

Turning to the intersection of big-bank and little-guy bailouts, a contact in the housing ATM notes that more folks than ever are electing not to pay their mortgages. Apparently, the thinking goes something like: "Gee, if some folks are not paying their mortgages and are going to get bailed out, why shouldn't I? Particularly if I have a little equity in my house."

That is the danger that's been created by the government talking about bailing out the housing market: A multitude of people decide to join the party and not pay. This is a slippery slope we've been going down for a long time, and it looks at long last like the problem will be too big to bail out. Bottom line: The dislocation and pain are starting to be felt throughout the financial system. We are headed to a lot of financial turmoil, and there's no getting around that.

Could the fall of Rome hit home?

Lastly, in a sad commentary about where we are as a country, U.S. Comptroller General David Walker was quoted Tuesday (also in the Financial Times), as follows: "Drawing parallels with the end of the Roman empire, Mr. Walker warned there were 'striking similarities' between America's current situation and the factors that brought down Rome, including 'declining moral values and political civility at home, an overconfident and overextended military in foreign lands, and fiscal irresponsibility by the central government.' "

Unfortunately, it seems to me that he is dead right.

How we got here

Washington — For most of this decade, buyers of homes and businesses enjoyed "easy" credit, allowing them to get low-interest loans with few questions asked.

Suddenly, credit has become "tight." That means people with spotty credit records are no longer getting mortgages, the largest home borrowers are paying higher interest rates, and some corporate buyouts are in jeopardy.

The changes have spooked financial markets and affected lenders, including Atlanta-based HomeBanc, which has filed for Chapter 11 bankruptcy protection, and Countrywide, the largest U.S. mortgage lender.

But how did credit get so easy in the first place — and what's making it so tight now? And will any of this matter to people who aren't buying a house or a corporation?

Yes, it may well matter, many economists say. They say credit troubles could further depress residential construction, which would push up unemployment. That, in turn, would shake consumer confidence and reduce sales of everything from cars to Christmas presents. Rising loan defaults also could further rattle financial markets. All of this together could trigger a severe recession, perhaps for the entire global economy.

But that worst-case scenario may never play out. Instead, optimists believe the free-market system already is weeding out bad loans and lenders, and calm will soon return.

That's President Bush's outlook. Recently, he told reporters he believes the market "will be able to yield a soft landing."

Patrick Newport, an economist with Global Insight Inc., a forecasting firm, agrees. "We don't think this will lead to a hard landing — a recession," he said.

But Newport added that he is less confident of that outcome than earlier this summer, because the credit tightening has been so severe. "We are a lot more worried than we were a month ago," he said.

Origins in S&L crisis
The story of how the nation got to this precarious point stretches back to the 1980s, when the savings and loan industry collapsed.

In the aftermath of that disaster, regulators began insisting that banks and thrifts with insured deposits start holding more capital to offset risky loans. That spurred the rapid growth of mortgage companies that got their money not from insured depositors, but by selling "securitized" mortgages that were bundled so they could be easily sold like bonds to investors who collected the interest payments.

These companies were regulated less than banks and thrifts, and during the 1990s, many of them started lowering their standards to boost business. For example, instead of requiring borrowers to fully document all income, some started offering no-documentation loans. Initially, such loans would cover no more than 70 percent of the value of the house being bought. But over time, lenders began offering "no-doc" loans for as much as 100 percent of the value.

Also starting in the 1990s, lending got a major boost from falling interest rates that made borrowing much cheaper. First, the 1997 Asian financial crisis drove up demand for safe U.S. Treasury securities, allowing the U.S. government to offer its long-term bonds for low interest rates.

Then, short-term rates took a plunge after the Sept. 11, 2001, terror attacks. The Federal Reserve Board, afraid the U.S. economy would not recover quickly from the assault, started cutting short-term rates and didn't stop until they reached 1 percent in mid-2003.

Buying was a breeze
Between the easy credit standards and low rates, borrowing became a breeze. As buyers snapped up properties, they pushed home prices higher.

Millions of people refinanced their homes or took out home-equity loans. Less affluent people stretched to buy houses before prices rose too far, and by 2006, "subprime" mortgages — the relatively expensive loans used by people with dicey income or credit histories — accounted for a fifth of all home loans The tricky new mortgages helped create some 12 million new homeowners.

On Wall Street, meanwhile, low interest rates helped private-equity firms borrow massive amounts to buy companies.

But eventually the credit party had to end, because the Fed started worrying the economy would overheat and kindle inflation. The Fed began in mid-2004 to steadily push up short-term rates, finally reaching 5.25 percent in mid-2006.

By then, many of the home loans made between 2003 and 2005 were going bad. People who had purchased homes with low "teaser" rates on subprime mortgages suddenly found themselves unable to keep pace as payments moved up.

Meanwhile, investors who had bought securitized mortgages ended up holding a lot of bad loans. The turmoil has caused huge financial headaches for lenders.

Now, with investors no longer eager to pour money into "securitized" mortgages, even the most stable lenders have less access to fresh cash for would-be home buyers. And corporate buyouts that depend on borrowed money are slowing too.

Central banks around the world have been pumping cash into financial markets to calm worries about a growth-choking global credit crunch. A sharp reduction in the availability of credit could trip up everyone from a family trying to get a home equity loan to remodel the kitchen to private-equity investors trying to complete a buyout of Texas utility TXU Corp.

Optimists think the worst is over. They note the European Central Bank said this week that market conditions have started "normalizing." Upbeat economists believe the lending problems will clear up as mortgage companies eliminate their riskiest practices.

But others still see huge risks. If interest rates keep rising, far more Americans may find they can't afford their homes. Then investors holding securitized mortgages would get stuck with more bad loans. The cycle of foreclosures and investment losses could cause home prices to plunge, financial markets to drop and unemployment to rise.

"Consumer spending is the driver of this economy," said Ron Blackwell, chief economist for the AFL-CIO, a labor organization. "If this cascades and turns into a falling housing market, then there is nothing left driving this economy."

Easy money no more

Instead of its normal home page, the Web site of mortgage lender First Magnus Financial now reads, "In light of the collapse of the secondary mortgage market, First Magnus will not fund any future mortgage loans."

Think the global credit crunch is something distant?

Not if your loan was in the pipeline from First Magnus, which made $30 billion in mortgages last year and employs 5,000 people, all of whom were sent home from work -- apparently for good -- on Thursday.

The First Magnus episode is becoming all too common, and that phenomenon is making itself felt in Southwest Florida, where real estate is the king of the hill.

"A lot of lenders I used to work with are going out of business," said Marta Grande, a Sarasota mortgage broker who had counted on First Magnus for quite a few loans up until this week. "I would have to say about 40 percent."

The credit crisis is like a hangover after a party that was just too good to be healthy.

"All of us in the food chain -- bankers, builders developers, mortgage lenders -- I would say we all got a little bit intoxicated with the market," said Jody Hudgins, Florida executive for the First National Bank of Pennsylvania, which operates in Sarasota and five other Florida communities.

The meltdown -- besides its obvious repercussions on Wall Street -- has made it harder and harder for people to get a home loan, much less refinance one of the more exotic mortgages so popular in the boom years.

"As far as getting a loan, it is a real, real struggle to get somebody with good credit a loan," Grande said.

Even very prosperous investors like Sarasota's Harvey Vengroff, founder of the world's largest debt collection agency, are running into extreme makeovers on their real estate loan paperwork.

"One is for $5.7 million on a property that was a no-brainer a couple of months ago," groused Vengroff. "Now they're asking for more information and checking their verbiage and doing other stupid stuff."

In the current credit crisis, the financial world seems to be reliving the old childhood song about the knee-bone being connected to the thigh-bone. The media has put nearly all its attention on defaults for so-called subprime mortgages -- loans made to customers with below-average credit ratings. However, less exotic creations like "no-documentation loans" for those with high credit ratings and big bank accounts, and even normal real estate loans for investors, are becoming rarer.

"It all kind of went down with the subprime, but that's all everybody hears about," said Max Shaw, a residential lending officer at People's Community Bank in Sarasota.

Like Grande, he said that so-called "Alt-A" loans, where the buyer had very good credit and the lender was willing to take the borrower's word on income without checking it, have nearly vanished.

"It is just getting back to the way it should be," Shaw maintains. "It is just that you are going to have to have decent credit and you are going to have to prove you have what you say you have."

Choice or no-choice?

In 2004 and 2005, lenders fell over one another to provide loans with the lowest front-end cost possible.

One of these was the option ARM, in which borrowers had three choices every month: a full payment of principal and interest, an interest-only payment, or a minimal payment like a customer would see on a credit card bill.

Borrowers who took the easy way out saw the unpaid interest stacked on top of the original loan amount. That happened until the loan hit a pre-set trigger amount. Three or four years into the loan, or after the trigger gets pulled, the choice turns into a no-choice fixed-rate loan with less than 30 years left on it.

The nation is still about 18 months away from feeling the full impact of those loans, because they reached their peak popularity about two years ago, said Sarasota's Bob DeCecco, the former head of Opteum Financial Services' Florida operations who left the company this week.

Complicating matters further, those option ARMs were frequently used to dish out 100 percent financing.

"So these individuals got 100 percent loan-to-value loans, on properties that are now depreciating, with interest rates increasing, and a tighter credit market, in which they would not even re-qualify for that program," DeCecco said.

"They have to refinance, and they can't."

Want a home loan? Shaw, the People's lending officer, said he has plenty of money to lend -- for those planning to move into the home. "You can get a 30-year fixed right now around 6.5 percent with no points."

OK, but what about an investor seeking to buy and then rent out a bargain home being made available by a desperate seller?

"I couldn't even quote you investor money," Shaw said.

If someone could get an investor loan at People's Community, it would probably be at a point or a point and a half higher than the primary residence quote, which would puts it at 7.5 percent to 8 percent, Shaw said.

Lenders have also put the kibosh on investor loans without substantial down payments.

"Twenty five percent cash, minimum," Shaw said, adding that even then, "they are hard to get done. You've got to have stellar credit, a solid profile. It is just extremely tough right now."

Most of this tightening has come within the past two months, he said. "Where you started seeing all these lenders drop out, there is when every other lender started tightening up."

Collateral damage

The collateral damage from cheap money turning expensive is definitely not limited to consumers.

The run-up in volume and prices on expensive homes during the first half of the decade caused developers and builders to bolt herd-like to grab property for future construction.

In nearly every case, there was a banker at the front end making a construction loan with an interest payment reserve to tide the developer over while he or she prepared the property for eventual sale.

With those projects now getting postponed in Southwest Florida's slow housing market, those interest payment "set-asides," in some cases, are now running out, said Hudgins, the First National Bank of Pennsylvania executive.

"The collision is when our developer friends for three years have had these interest reserves abundantly provided for, and now there is no more room in the property for additional interest reserves due to the declining property values," Hudgins said.

A lot of those real estate speculators and developers will not have the money to carry the debt. Banks will then be faced with "limited options," one of which is foreclosure, he said.

"Nearly every banker in Florida got seduced," Hudgins said. "What we never put into the equation was how much of the purchasing was fueled by easy money -- cheap money, foolish money -- from lending sources that were desperate to meet their production needs."

Cash is king

As in any credit crunch, this one included, cash is king.

Vengroff is having a field day buying up his favorite kind of property: apartment buildings aimed at tenants with moderate income.

"I haven't even been in town and I bought two this month," said Vengroff, speaking on his cell phone from Connecticut.

His latest deal is a 21-unit apartment building at Lime Avenue and Sixth Street, "a property somebody else was failing on," he said. It was appraised last year for $1.15 million. Vengroff bought it for $850,000 and got a $600,000 loan from a local bank.

"In this case, we needed $250,000, which is about a third of the purchase price, which is the way we do most of our deals," Vengroff said.

Those would be have been tough terms for most buyers even during the boom. But back then, it was simple to find lenders with easier terms.

"Those people are losing their properties right now, and I think that is the difference," Vengroff said.

Vengroff's latest deal seemed to cheer up Hudgins.

"On the surface that seems like a very shrewd, wise investment," the banker said. "I am betting that he may be netting 15 percent."

A rush to pull out cash

THE MORTGAGE MELTDOWN

Worried about the stability of mortgage giant Countrywide Financial, depositors crowd branches. In Laguna Niguel, Bill Ashmore drove his Porsche Cayenne to the bank's office and waited half an hour to cash out $500,000. "It's got my wife totally freaked out," he said.

By E. Scott Reckard and Annette Haddad

August 17, 2007

Anxious customers jammed the phone lines and website of Countrywide Bank and crowded its branch offices to pull out their savings because of concerns about the financial problems of the mortgage lender that owns the bank.

Countrywide Financial Corp., the biggest home-loan company in the nation, sought Thursday to assure depositors and the financial industry that both it and its bank were fiscally stable. And federal regulators said they weren't alarmed by the volume of withdrawals from the bank.

The mortgage lender said it would further tighten its loan standards and make fewer large mortgages. Those moves could make it harder to get a home loan and further depress the housing market in California and other states.

The rush to withdraw money -- by depositors that included a former Los Angeles Kings star hockey player and an executive of a rival home-loan company -- came a day after fears arose that Countrywide Financial could file for bankruptcy protection because of a worsening credit crunch stemming from the sub-prime mortgage meltdown.

The parent firm borrowed $11.5 billion Thursday by using up an existing line of credit from 40 banks, saying the money would help the lender meet its funding needs and continue to grow. But stock investors, apparently alarmed that the company felt compelled to use the credit line, sent Countrywide's already battered stock down an additional 11%.

At Countrywide Bank offices, in a scene rare since the U.S. savings-and-loan crisis ended in the early '90s, so many people showed up to take out some or all of their money that in some cases they had to leave their names.

In West Los Angeles, a Countrywide supervisor brought in from another office served coffee to more than 25 people waiting calmly for their turn with the one clerk who could help them.

Bill Ashmore drove his Porsche Cayenne to Countrywide's Laguna Niguel office and waited half an hour to cash out $500,000, which he then wired to an account at Bank of America.

"It's because of the fear of the bankruptcy," said Ashmore, president of Irvine's Impac Mortgage Holdings, which escaped bankruptcy itself recently by shutting down virtually all its lending and laying off hundreds of employees.

"It's got my wife totally freaked out," he said. "I just don't want to deal with it. I don't care about losing 90 days' interest, I don't care if it's FDIC-insured -- I just want it out."

Customers, most of whom said they were acting just in case, said they went to the lightly staffed branches because they couldn't get through to the bank via its toll-free number or its slow-moving website.

"I doubt it will go under, but I want to protect myself," said Rogie Vachon, who was the Kings' most valuable player for several years in the '70s. Vachon said he went to the West L.A. branch to withdraw some money because his account balance exceeded the limit on insurance provided by the Federal Deposit Insurance Corp.

In a statement, the bank said: "It is very important to remember that Countrywide Bank is well capitalized, with FDIC-insured deposits, and is one of the largest banks in the United States, with assets over $107 billion."

The bank added that it had significant access to outside capital and was still highly rated by debt-rating firms.

As for parent firm Countrywide Financial, the mortgage giant said draining its credit line would allow it to continue operations while refocusing its business on the "plain vanilla" mortgage loans that can be sold to Fannie Mae and Freddie Mac, the government-sponsored mortgage finance companies.

Countrywide said it planned to fund more mortgages through Countrywide Bank and have the bank invest in certain loans that Fannie Mae and Freddie Mac won't buy, such as "jumbo" mortgages, which in California are defined as those over $417,000.

Countrywide recently was funding about $40 billion a month in mortgages. Of those, about half qualified to be sold to Freddie Mac or Fannie Mae, and half were "nonconforming" loans the agencies don't buy, including sub-prime mortgages to higher-risk borrowers as well as jumbo loans, which account for 43% of all mortgages issued in Southern California.

Company executives declined to discuss how the heavy withdrawals at Countrywide Bank branches Thursday might interfere with that strategy.

Mortgage industry executives, however, said that although Countrywide Bank was the nation's third-largest savings and loan, after Washington Mutual and Wachovia Bank's World Savings unit, it was far too small to absorb the entire $20 billion a month in nonconforming loans Countrywide Financial produced.

As a result, the company is likely to make fewer loans while applying more stringent criteria in deciding who gets them -- a transition that could further pinch the strained housing market.

In recent months, sales of high-end houses have been stronger than those for cheaper homes. Now, with a pullback in larger loans by Countrywide and other major lenders, the weakness at the low end is likely to spread upward, said Esmael Adibi, director of Chapman University's Anderson Center for Economic Research.

"The implication will be declining home prices, higher foreclosures, a significant slowdown in spending by consumers," he said. As home sales fall further, "ultimately job growth will slowly deteriorate."

Those long-term concerns weren't the first thing on the minds of depositors withdrawing money Thursday.

At a branch near Countrywide's corporate headquarters in Calabasas on Thursday, a flood of spooked customers seeking to withdraw their certificates of deposit and money-market accounts overwhelmed the small staff.

The Countrywide employees were forced to resort to taking down names and asking people to wait it out or come back later.

"I'm at the age where I can't afford to take the risk," a 69-year-old retiree who asked not to be identified said after transferring money out of his money market account. "I'll gladly put it back as soon as I know the storm is over."

After reading news reports of Countrywide's troubles, Elsie Ahrens of Calabasas decided to close two of her CD accounts at Countrywide.

"It's not worth it," said Ahrens, 42. "I don't think it's going to go under, but you never know."

Ahrens, who runs a voice and data business, took her money and opened a new account at Bank of America, which she said felt more secure and offered a comparable interest rate.

In Laguna Niguel, Ashmore, the Impac Mortgage president, remarked on how the credit problems stemming from sub-prime loans had filtered down to a local bank branch.

"It started out with this global credit crunch we've been reading about," he said as another Countrywide depositor left the bank's office. "It's now gotten down to affecting people like him and me who are closing our accounts."

The other depositor shook his head as he climbed into his car.

"It's all over," he said, and drove away.

Batting for the cycle

This is not new. It is as old as financial capitalism itself. The late Hyman Minsky, who taught at the University of California, Berkeley, laid down the canonical model. The process starts with "displacement", some event that changes people's perceptions of the future. Then come rising prices in the affected sector. The third stage is easy credit and its handmaiden, financial innovation.

The fourth stage is over-trading, when markets depend on a fresh supply of "greater fools". The fifth stage is euphoria, when the ignorant hope to enjoy the wealth gained by those who came before them. The warnings of those who cry "bubble" are ridiculed, because these Cassandras have been wrong for so long. In the sixth stage comes insider profit-taking. Finally, comes revulsion.

The escape of the enablers

When Wall Street fails, it inevitably asks for a handout. Fortune's Allan Sloan says there must be a better way.

By Allan Sloan, Fortune senior editor-at-large

August 17 2007: 9:39 AM EDT

NEW YORK (Fortune) -- Wall Street loves to talk about letting financial markets weed out the weak. But when the Street itself gets in trouble, it sticks out its little tin cup, asking for help. And gets it.

The subprime-mortgage-market meltdown is a classic example of the way small fry get devoured, but the whales of Wall Street get rescued. Here's the deal: People with crummy credit who took out mortgages are being allowed to fail in record numbers. The mortgage companies that made those loans are being allowed to fail.

The Street itself? It's bailout city. Even before the Fed made a symbolic half-point cut in the discount rate, it and other central banks from Switzerland to Singapore were trying to rescue the Street by injecting hundreds of billions of dollars into the financial markets and announcing they will put up more, if needed.

Hello? If you believe in markets - which I do - this rescue is especially galling, because Wall Street enabled this mess in the first place. How so? By happily sucking up hundreds of billions of dollars' worth of suspect mortgages from marginal U.S. borrowers-and begging mortgage makers to create more of them. The Street sliced and diced this financial toxic waste into a variety of esoteric securities, making a nice markup when it sold them and generating a continuing stream of profits when it made markets in them.

Somehow analysts at credit-rating agencies, looking at computerized scenarios rather than at the real world, decided that the bulk of the securities backed by these trashy loans could be rated triple-A.

It's really amazing: Most of the loans to substandard creditors borrowing 100% of the purchase price of homes they couldn't afford were rated the same as GE and the federal government. That makes no sense. But the money rolled in, and Wall Street-by which I mean the world's biggest and most important financial institutions-didn't care about the real world or ask any questions. It was too busy making money, and cashing bonus checks generated by subprime-mortgage profits.

But the world's central banks aren't letting the big guys fail. Think of it as the Escape of the Enablers. The reason this is happening, of course, is the same reason that the Fed orchestrated a bailout of the infamous Long-Term Capital Management hedge fund a decade ago-and about 20 years ago didn't close some of the nation's biggest banks, even though they were effectively insolvent because unrealized losses had wiped out their capital.

It's the "too big to fail" syndrome. In a world in which big players make incredibly large and complex deals with one another - that's what derivatives are - regulators don't dare let a big or important institution fail for fear that the collapse of one would lead to "cascading failures," and other institutions wouldn't be able to collect what the collapsed institution owed them.

The Fed's job, you see, isn't to protect you and me and our retirement portfolios, or even many of the nation's largest companies and biggest employers. The Fed's job is to protect the financial system. That's why it's trying to rescue the gigantic subprime enablers while letting borrowers and mortgage companies go under.

Your collapse or mine wouldn't bother Fed chairman Ben Bernanke or the world's other central bankers. But if, say, a big German institution loaded to the eyeballs with subprime securities croaked, Bernanke and his fellow central bankers would care a lot.

Sure, we know that Ben and the boys will always bail out the biggies. And none of us - I think, anyway - wants the world's financial system to implode. But I'd feel a lot better if the Street had to pay a serious price to its rescuers--say, having to fork over a big equity stake and pay a loan-shark interest rate. That way taxpayers, who are picking up the tab for the rescue, would get paid bigtime for taking on bigtime risk.

After all, that's the Wall Street way.

Countrywide Borrows $11.5B From 40 Banks

Thursday August 16, 9:37 am ET
By Stephen Bernard, AP Business Writer Countrywide Borrows $11.5B From 40 Banks to Fund New Loans As Industry Faces Credit Crunch

NEW YORK (AP) -- The nation's largest mortgage lender borrowed $11.5 billion from a group of 40 banks to fund loans, in a move that shows just how deep the lending crisis has become.

Countrywide Financial Corp. said Thursday it made the move amid a credit crunch that has driven a number of its smaller peers to bankruptcy. Shares opened down more than 12 percent.

"Countrywide has taken decisive steps which we believe will address the challenges arising in this environment and enable the company to meet its funding needs and continue growing its franchise," Countrywide President and Chief Operating Officer David Sambol said in a statement.

The credit worries have grown as the secondary market for mortgages all but disappeared in recent weeks. Investors have worried about the value of loans and rising delinquencies and defaults.

Mortgage lenders rely on the secondary markets to borrow money to make more loans. The problems started as subprime mortgages -- loans given to customers with poor credit history -- started going delinquent and defaulting at faster rates.

The problems have spread to the broader mortgage market, making investors nervous about nearly all types of loans that cannot be purchased by Fannie Mae or Freddie Mac.

Such "conforming" loans are considered safer because Fannie and Freddie are government-sponsored entities. Countrywide said some 90 percent of the loans it originates from now on will be conforming loans or will meet its internal bank criteria.

By adjusting its product mix to originate Fannie and Freddie-approved loans almost exclusively, Countrywide will be cutting out most subprime, alt-A and jumbo loan products.

Alt-A mortgages are given to customers who either have minor credit problems or who cannot provide full income documentation required to get a traditional prime loan. Jumbo loans are mortgages for more than $417,000, the cap at which Fannie and Freddie will purchase loans. Jumbo loans typically are given to customers with excellent credit history.

On Wednesday, a Merrill Lynch & Co. analyst downgraded Countrywide to "Sell," just days after calling it a "Buy," attributing the change to the rapid deterioration of the credit market. Friedman, Billings, Ramsey Group Inc. said Thursday a continued liquidity crunch for more than three months could send Countrywide into bankruptcy.

Asian stocks plunged overnight and European markets fell sharply Thursday as U.S. credit worries continue to spread to other countries.

Credit rating agency Moody's Investors Service downgraded Countrywide's senior debt rating to "Baa3" from "A3," citing Countrywide's funding problems.

A ratings downgrade essentially makes it more expensive for a company to borrow money. Countrywide could be further downgraded if it continues to face liquidity problems, Moody's said in a statement.

The new rating is Moody's lowest investment-grade mark. Any downgrade would take Countrywide into "junk" status, which would keep many large institutional investors from owning its debt.

Countrywide shares fell $2.64 to $18.65 in early trading, with more than 12.6 million shares turning over in the first two minutes of trading.

Mortgage meltdown contagion

A grim forecast has economists more pessimistic over how far the collapse will spread to the rest of the economy.

By Les Christie, CNNMoney.com staff writer

August 13 2007: 11:49 AM EDT

NEW YORK (CNNMoney.com) -- The outlook for the housing market looks even bleaker than it did a week ago. Last Friday we reported that foreclosures were skyrocketing, home prices falling and recovery forecasts were being scaled back.

And now this week, the mortgage meltdown spread to the financial markets with ebola-like speed, sparking fears that tighter credit will have a broader impact on consumers, markets and the economy.

The U.S. government continues to downplay the danger. When the Federal Reserve met this week, the central bank said that inflation is the greatest threat to the economy, not the mortgage crisis.

Yet, Countrywide Financial, the nation's largest mortgage lender by volume, reported Thursday that "unprecedented disruptions" in the mortgage market were forcing it to cut way back on the number of loans it was securitizing and selling in the secondary markets.

In the financial markets, credit, including corporate bonds, has become harder to get. Mark Zandi, chief economist of Moody's Economy.com, had been loath to call it a "credit crunch." Instead, he called it a "liquidity squeeze," that had spread to corporate bond and other financial markets. The difference: In a crunch, nobody can get a loan; in a squeeze, only the riskier borrowers are cut out.

"I think it's still a liquidity squeeze," Zandi now says, "but it has elements of a credit crunch, affecting much of the mortgage market."

It has yet to severely disrupt the prime loan market, however, according to Zandi. The situation will continue until financial institutions revalue their mortgage-backed securities to what they're actually worth.

"They're faced with redemptions and margin calls, and they have to value their securities to their market prices because they have to sell them," said Zandi. That will determine how hard a hit the investment community will take.

Peter Schiff, president of Euro Pacific Capital Inc. and author of "Crash Proof: How to Profit from the Coming Economic Collapse," has said the problem goes way beyond subprime.

"It's a mortgage problem," he said. "Subprime is like a little leak where the underlying problem is the integrity of the dam itself. Most of the mortgages taken out during the past few years will fail."

Schiff expects huge losses in the housing market with home prices falling by half in some areas, which he said has to affect the overall economy. He said he'd been expecting the financial markets to start taking hits long before this week's drop.

"This week is making more sense," he said. "The economy is a basket case."

Most economists are nowhere near as pessimistic. Standard and Poor's chief economist, David Wyss, and Moody's Economy.com's chief economist, Mark Zandi, have forecast 8 percent price drops in the housing market, peak to trough.

Zandi does not believe a consumer spending slowdown is enough to trigger a recession, but he hasn't counted it out. What it will do, he said, is "ensure that the economy grows at a pace below its potential. I wouldn't dismiss the possibility of a recession. I put the possibility at one in five."

Ken Goldstein, an economist for the Conference Board, has said he doesn't believe the subprime contagion is enough to send the economy off-track, and that "the idea that average consumers are quaking over the prospects of losing their homes or much of their equity is wrong."

Your Home: When to cash out

The mortgage market adds up to about $10 trillion, according to Goldstein, with about 10 percent to 15 percent of that in subprime. Of that, some 15 percent or so is imperiled, he said.

"It's big, but not the tipping point that will bring the whole housing market down."

But on Friday Goldstein did concede that "The panic and concern over credit is even spreading across the pond to European markets."

On Friday the European Central Bank (ECB) pumped extra cash into the system for a second day in a row, as a means of calming nervous traders. The ECB added $83 billion in liquidity Friday.

The Federal Reserve followed suit, adding $19 billion in temporary reserves. The move was the biggest single temporary open market operation in four years, the New York Federal Reserve said, according to Reuters.

Subprime problems have not, so far, slowed consumption down much. The pace of consumer spending is still brisk, although growth slowed in June. And the Conference Board reported last week that consumer confidence is at a six-year high. Steady job growth and low unemployment (between 4.4 percent and 4.6 percent since September) have kept it that way.

Consumers don't really care much about changes in housing prices or, for that matter, in the stock market, according to Goldstein.

"If you really want to screw up consumer confidence," he said, "go for the jugular - the labor market."

Said Mark Sirinyan of Ineo Capital, an alternative-asset advisory firm, "I don't think there will be a recession because of private equity or the credit markets alone. There are lots of other reasons it could happen - we're fighting a war and spending money."

And according to Schiff, "What [the optimists] don't realize is that consumer spending has been a function of easy credit and the high housing market. The idea that Americans will keep spending is wrong. With [lower home equity and less access to credit] where're they going to get the money?"

Steven Cesinger, chief financial officer for Dewberry Capital, said, "People think liquidity will carry us forward. I've been in financial markets for 25 years and i've seen that the faucet can turn off as rapidly as it turns on."

According to Goldstein, though, as long as employment stays strong and workers' earnings grow substantially (4 percent annually, according to him), confidence - and spending - will remain high and the economy will chug along.

"Consumers can continue to stay resilient in the face of lower stock and home prices," he said. "Not only is the economy strong enough to survive the crisis, it's strong enough to quiet it."