Penleymortgage BLOG

Kerry Killinger is chairman and CEO of Seattle's Washington Mutual Inc., which has about 2,200 banking branches in the West as well as New York and Connecticut, and another 500 loan offices nationwide. Killinger has been with Washington Mutual for a quarter of a century - including 17 years as the CEO - after stints in securities brokering and insurance. He has overseen 31 acquisitions that helped expand Washington Mutual from a regional S&L into the nation's largest thrift.

The following has been edited for length and clarity.

Q: In broad terms, could you tell us your impression of what happened in the mortgage market and how it happened? Foreclosure activity is increasing as adjustable-rate loans are reset. Who is to blame?

A: House price appreciation in the United States was significantly above normal for several years and it was fueled by a strong economy, low interest rates, limitations on the supply of housing from building restrictions in some parts of the country, and increasing demand.

That led to price increases growing above average. That then accelerated into a bit of a bubble as speculators came into the market thinking that housing was going to increase in value at an above-average rate forever. The market peaked about two years ago. Simply, prices were rising much faster than they should have.

Another factor that fueled that speculation in housing was an abundance of money flooding into the housing market from Wall Street. I call it irrational money. That caused underwriters to decrease their credit standards because they were originating to the criteria that those investors were asking for. Those sources of Wall Street funding in many cases were hedge funds and nontraditional bank lenders.

What's happened in the last 12 months is an unwinding of that process in which housing prices have started to slow their increases and in some markets have actually started to decline. That in turn has caused buyers who were there for speculation to start to back out.

It also caused the delinquency rates in virtually all loan categories to increase. Not just subprime but Alt-A and prime loans and home-equity loans. Delinquencies are rising in all of those categories because home prices are slowing down.

Interest rates are still relatively low and the economy is relatively strong, so people still have jobs. So the severity of that correction in housing prices has been somewhat helped by those factors.

On the liquidity side, the sources of what I call the irrational money from Wall Street are now reversing themselves, and they're now seeing that the underwriting they helped set was too loose, and the credit losses are rising to levels well above their expectations. In a short period of time, those sources of liquidity are drying up.

Today there is starting to become a shortage of capital available for housing. The moderating influence on that is that banks and others, like ourselves, who have plenty of capital and good liquidity, we continue to be very interested in making home loans, but the underwriting we are using is more conservative than what was taking place when the money was flush from Wall Street.

Bernanke, Trichet Urged by Markets to Do Rates U-Turn (Update1)

Federal Reserve Chairman Ben S. Bernanke.

Aug. 13 (Bloomberg) -- Credit markets are telling central banks what to do, and it isn't what Ben S. Bernanke or Jean- Claude Trichet had in mind.

Days after reaffirming their interest-rate stance against inflation, central bankers may be forced to do an about-face. Traders are paring bets on imminent rate increases in Europe and Japan, and some even speculate the Federal Reserve may execute an emergency cut.

Behind the changed outlook is concern that the steps central banks have already taken -- pumping cash into markets over three days to avert a credit collapse -- won't be enough to keep global growth from stalling. In the days before, Fed Chairman Bernanke, 53, and European Central Bank President Trichet, 64, were saying inflation, not financial instability, was the biggest risk.

``The dramatic moves by many of the world's central banks could imply that we have a whole new ball game when it comes to monetary policy,'' says David Brown, chief European economist at Bear Stearns Cos. in London.

Just before last week's turmoil, Trichet signaled the ECB would lift its benchmark rate in September, and Bernanke indicated the Fed had no plans to cut rates. On Aug. 8, Bank of England Governor Mervyn King, 59, said he didn't see ``an international financial crisis;'' investors were merely reappraising risk.

Weakened Positions

Their positions were undermined when fallout from the U.S. subprime crisis spread abroad after BNP Paribas SA, France's largest bank, halted withdrawals from three investment funds because it couldn't value their holdings. The Fed, ECB and other central banks added $154 billion to the banking system on Aug. 9 and $135.7 billion on Aug. 10. The ECB injected $65 billion today. The last similar effort to prevent rising market interest rates from getting out of hand was just after the 2001 terrorist attacks.

As the new week begins, the risk is the extra liquidity won't keep money flowing through the financial system, threatening to push up borrowing costs on everything from mortgage loans to credit cards and hobbling economic expansions. That may force central banks to rethink their monetary policy strategies.

``Such developments indicate substantial stress and central banks don't usually like to compound this by raising policy rates as well,'' said Julian Callow, chief European economist at Barclays Capital in London. ``Actions by the ECB and Fed so far appear only to have been buying time.''

Reduced Expectations

In Europe, investors reduced expectations for higher rates in the U.K. and the 13-nation euro area. Traders see an 80 percent chance the ECB will raise rates in September, down from 90 percent on Aug. 8. They have also abandoned bets, made a month ago, on two rate increases from the Bank of England by the end of the year even though the U.K. has been alone among central banks in the Group of Seven in not pushing liquidity into the market.

The Bank of Japan may be the first to blink when its policy makers convene next week. The chance of the bank's increasing borrowing costs at that meeting was at 32 percent today compared with 75 percent on Aug. 9, according to calculations by Credit Suisse Group.

Federal funds futures indicate investors are betting the Fed will cut its target rate of 5.25 percent by a quarter percentage- point at its Sept. 18 meeting.

``It is not inconceivable that such an easing could occur within days if market conditions continue to deteriorate,'' says Jan Hatzius, chief U.S. economist at Goldman Sachs Group Inc. in New York.

Early Cut

Two-year notes reinforce the idea the Fed will cut borrowing costs before September. The yield on two-year notes, more sensitive to expectations for Fed policy, was at 4.49 percent, or 0.76 percentage point less than the Fed's key rate.

The last time the gap was wider than its level of this month was in 2001, when the central bank, under former Chairman Alan Greenspan, reduced rates 11 times -- to 1.75 percent from 6.50 percent -- to try to pull the economy out of a recession.

That year was also the last time the Fed lowered rates outside a regularly scheduled meeting, which it did three times in 2001. The first, on Jan. 3, came just two weeks after policy makers had changed their view that inflation posed the main threat to the U.S. economy. Subsequent actions came in April and again in September, the latter to shore up consumer and investor confidence following the terrorist attacks that month.

`Faced With a Crisis'

While the Fed hasn't faced such a challenge with Bernanke as chairman, ``there's no reason to be concerned they'll feel hemmed in when faced with a crisis,'' says Brandeis University economics professor Stephen G. Cecchetti, former director of research at the Federal Reserve Bank of New York.

Still, Bernanke isn't under the same pressures to cut rates quickly that Greenspan faced during his career, which spanned the 1987 stock-market crash and the 1998 Asian currency crisis, as well as the terrorist attacks.

``Bernanke is in a little bit better position to make independent decisions without too much pressure from other parts of the government,'' says Scott Pardee, former head of foreign- exchange operations at the New York Fed and now a professor at Middlebury College in Vermont. ``It isn't one of these things where everyone in the world is calling on the Fed to lower interest rates.''

The Fed may have done enough after adding $62 billion to the banking system on Aug. 9 and 10 and pledging further funds as necessary, says Dominic Konstam, head of interest-rate strategy at Credit Suisse in New York. Stocks rallied worldwide today and U.S. index futures advanced, while the ECB said today it's optimistic that ``market conditions are normalizing.''

`Liquidity Issue'

``The Fed is going out of its way not to cut rates to resolve the liquidity issue,'' Konstam says.

A major reason for caution at central banks is the risk that a premature rate cut compromises their effort to contain inflationary pressures stoked by the fastest global growth in three decades. Inflation in China accelerated to the highest rate in more than a decade in July, the National Bureau of Statistics said today.

Charles Goodhart, who sat on the Bank of England's panel between 1997 and 2000, says that's what happened after central banks in Europe and the U.S. cut rates in response to the 1998 currency crisis, only to see inflation accelerate and asset bubbles inflate during the next two years.

``Central banks reduced rates and very quickly wished they hadn't,'' he says. ``The rate decision had to be reversed quite sharply to deal with the major upturn that we saw from 1998 to 2000.''

For now, some economists are loath to make concrete predictions. JPMorgan Chase & Co. says a forecast that 15 of the 31 central banks it covers will raise rates before October depends on ``normal'' market conditions returning.

``We're in a situation where I don't think anyone knows what will happen next,'' says David Mackie, the bank's chief European economist in London.

Bernanke Was Wrong: Subprime Contagion Is Spreading (Update2)

Aug. 10 (Bloomberg) -- Federal Reserve Chairman Ben S. Bernanke was wrong.

So were U.S. Treasury Secretary Henry Paulson and Merrill Lynch & Co. Chief Executive Officer Stanley O'Neal.

The subprime mortgage industry's problems were contained, they all said. It turns out that the turmoil was contagious.

The $2 trillion market for mortgages not backed by government- sponsored agencies is at a standstill. That's just the beginning. Other types of mortgages are suffering. So are firms and banks that package the debt for investors. The ripples were felt in Europe and Asia, where central banks offered cash to banks amid a credit crunch. And some corporations, from countertop makers to railroads, are blaming the mortgage meltdown and housing slump for earnings that fell short of analysts' estimates.

Even a mobile-phone company, Dallas-based MetroPCS Communications Inc., says it's feeling the pinch from customers facing foreclosure. And experts such as William Ford, former president of the Federal Reserve Bank of Atlanta, say the chance of a recession is growing.

``Housing created a lot of ancillary economic activity and jobs, and now we are in the reverse process,'' says Paul Kasriel, chief economist at Northern Trust Corp. in Chicago and a former Fed economist.

Fed Intervention

The Federal Reserve today provided $38 billion of reserves to the banking system and pledged further funds ``as necessary,'' in a statement unprecedented since the aftermath of the Sept. 11, 2001, attacks. The Fed had released $24 billion in temporary funds yesterday, the most since April.

The European Central Bank today made a second loan to banks to alleviate a money shortage sparked by concerns over investments in U.S. mortgages. Today's loan of 61.05 billion euros ($83.4 billion) brings the two-day total of money lent to 155.85 billion euros ($212.9 billion).

The ECB's unprecedented move followed the freezing of three funds managed by BNP Paribas, France's largest bank, because the bank couldn't calculate how much the funds' holdings were worth due to a lack of buyers.

Today, the Bank of Japan made similar moves to supply cash.

`Spreading to Banks'

``The subprime mess is now spreading to banks,'' says Nariman Behravesh, chief economist at Global Insight Inc. in Lexington, Massachusetts. ``A lot of international banks, especially those in Europe, did invest a lot in the collateralized debt markets, especially the subprime situation here in the U.S., so they're suffering.''

Peter Lynch, chairman of private equity fund Prime Active Capital Plc in Dublin, said the ECB was ``treating this like an emergency.''

Bernanke told Congress on March 28 that subprime defaults were ``likely to be contained.'' The Fed chief, who declined to comment for this story, changed his assessment last month.

On July 18, he told Congress that ``rising delinquencies and foreclosures are creating personal, economic and social distress for many homeowners and communities -- problems that likely will get worse before they get better.''

Paulson Comment

Paulson said June 20 that subprime fallout ``will not affect the economy overall.''

This week on CNBC, he provided a less definitive assessment, saying that markets have been ``unsettled largely because of disruption in the subprime space.''

``We've had a major correction in that housing sector,'' Paulson said. ``It will take a while for the impact of that to ripple through the economy as mortgages reset.''

O'Neal on June 27 called subprime defaults ``reasonably well contained.'' Merrill spokeswoman Jessica Oppenheim said this week that the company is confident his words accurately reflected the market at the time. O'Neal declined to comment.

Among the other executives joining the chorus was Bank of America Corp. CEO Kenneth Lewis, who said June 20 that the housing slump was just about over.

``We're seeing the worst of it,'' Lewis said.

Within the week, he was contradicted by a team of Bank of America analysts, who called losses in the mortgage market the ``tip of the iceberg'' and predicted ``broader fallout'' from adjustable-rate loans resetting at higher interest rates.

David Olson, president of Wholesale Access Mortgage Research & Consulting Inc. in Columbia, Maryland, is blunt about his current outlook. He says a third of the U.S. home-loan industry will disappear.

American Home Mortgage

With last week's collapse of American Home Mortgage Investment Corp., which sold $58.9 billion of loans to borrowers in 2006, the subprime contagion spread to so-called Alt-A mortgages, which are available to borrowers with good credit who don't want to verify their income with tax forms or pay stubs.

American Home couldn't find Wall Street firms willing to buy these mortgages and package them into securities because of rising defaults. The Melville, New York-based company filed for bankruptcy Aug. 6.

``This is just the first, because all the Alt-A guys are going to go,'' Olson says. ``This is the most difficult mortgage environment I've seen in my 40 years in the business.''

This grade of loan made up 13 percent of all mortgages last year, according to Inside Mortgage Finance. Combined with subprime, they account for a third of the market. Both types of loan are rapidly disappearing.

Housing Prices

U.S. housing prices will fall this year, the first annual decline since the Great Depression of the 1930s, according to the National Association of Realtors, based in Chicago.

The inventory of unsold U.S. homes in May was the largest since the realtors group started counting them in 1999. Defaults and foreclosures may increase because about $1 trillion of payments on adjustable-rate mortgages are scheduled to rise this year, hitting a peak in October, according to Credit Suisse.

Housing and related industries generate almost a quarter of U.S. gross domestic product, according to the Joint Center for Housing Studies at Harvard University in Cambridge, Massachusetts.

The mortgage fallout ``ensures the economy will grow well below its potential through the remainder of the year and next,'' says Mark Zandi, chief economist for Moody's Economy.com in West Chester, Pennsylvania, who predicts GDP growth of 2.5 percent this quarter and next. Second-quarter growth was 3.4 percent.

Lowered Forecast

Demand for loans to bundle into mortgage-backed securities came to a halt, crippling the subprime and Alt-A lending businesses. The exception was prime loans conforming to rules set by the biggest government-chartered agencies, Fannie Mae in Washington and Freddie Mac in McLean, Virginia.

Doug Duncan, the Mortgage Bankers Association's chief economist, says he's lowering the group's forecast on the total dollar value of new U.S. mortgages.

The association said July 12 that the value of mortgages sold would decline 7 percent this year to $2.6 trillion and 18 percent in 2008 to $2.3 trillion, from $2.8 trillion last year.

``Most of the market has shut down,'' Duncan says. ``This is not a normal event.''

Peter Hebert, a broker with Houston-based Allied Home Mortgage Capital Corp. in Ellicott City, Maryland, says it's getting tougher to find mortgages for his clients.

`Use a Credit Card'

For one self-employed borrower in Pennsylvania, with a 626 credit score, just above what's considered subprime, Hebert says he contacted three lenders. Last year, the borrower would have qualified for a 7.99 percent loan, Hebert says. This week, he received one offer for a 10.5 percent loan with a three-year prepayment penalty, meaning that if the borrower refinanced during that time he would be required to make six months of payments to the original lender.

``It would have been cheaper to use a credit card to pay for his house,'' Hebert says.

When it came time to lock in the rate, the lender pulled out, Hebert says.

``It was a hard thing to do, an emotional thing, to tell my borrower he was turned down for a rate that was high to begin with,'' he says.

The market is shifting, too, for firms that package loans into securities and sell them to investors. About $11.2 billion of private-label, or ``non-agency'' mortgage bonds -- those not guaranteed by Fannie Mae, Freddie Mac or Washington-based Ginnie Mae -- were sold in July, according to Michael D. Youngblood, portfolio manager and analyst at Friedman Billings Ramsey Group Inc. in Arlington, Virginia. That's down from $41.6 billion in June and from a monthly average of $86.6 billion this year.

Margin Calls

Luminent Mortgage Capital Inc., a San Francisco-based firm that packages mortgages for investors, cited ``a significant increase in margin calls'' for canceling its dividend.

Such firms borrowed money from banks to buy loans to create securities. When investors stopped buying the securities, the banks that made the original loan demanded their money back.

Many such firms that package securities will leave the business this year, says Guy Cecala, publisher of Inside Mortgage Finance.

``If you're an investment bank and you're losing stock value every week because of your connection to the mortgage industry, isn't it easier to cut ties?'' Cecala says.

Bank Stocks

Shares of the top 12 U.S. banks have declined 17 percent since June 1.

Yesterday, Countrywide Financial Corp., the biggest U.S. mortgage lender, said in a filing that ``unprecedented disruptions'' in the U.S. home-loan market may crimp its ability to lend. The company said it may be forced to retain more of the loans it makes to homeowners rather than selling them to investors and that it may have difficulty obtaining financing from its creditors.

Corporations outside the mortgage industry are taking a hit, too, as housing slumps. Burlington Northern Santa Fe Corp., the second-biggest U.S. railroad, said it shipped less lumber for homebuilding in the second quarter. DuPont Chief Executive Officer Charles O. Holliday Jr. said July 24 that the housing recession eroded demand for Tyvek weather barriers, used in 40 percent of new homes, and Corian countertops.

Steak n Shake

Steak n Shake Co., an Indianapolis-based fast-food chain, blamed a 4.3 percent decline in same-store sales in the third quarter partly on credit markets. ``Some segments of Steak n Shake consumers continue to be sensitive to high gasoline prices and mortgage interest rates,'' the company said in a statement yesterday.

Shares of MetroPCS, a prepaid mobile-phone service, fell 20 percent Aug. 3 after second-quarter sales missed analyst estimates. Chief Financial Officer J. Braxton Carter blamed customers' ``short-term economic disruptions,'' such as defaulting on their subprime loans.

As for the faulty initial predictions by Bernanke and others, go easy on them, says Josh Rosner, managing director at the New York investment research firm Graham Fisher & Co.

``There's no model for what's happening now in the housing and mortgage industries,'' Rosner says. ``We have to give Bernanke a chance. He is a reasoned and traditional central banker. He knows how to manage crazies.''

If you are used to being able to get 100% no money down financing on new home purchases and dont understand why its harder to do that today you need to read this.  

Since Dec 2006 there has been a rash of lender failures and bankruptcy filings which has caused the entire lending community to re-evaluate their guidelines and adjust their offerings.  

The old way of doing things was a socre of 580 qualified you for 100% 80/20 or one loan 100  with no MI... the last of the lenders offering that changed to mostly 620 or some even 640... which is going to make it much more difficult for borrowers with less than perfect credit 600 and below to obtain the financing they need...

this re-adjusting has also crept into the excellent credit set defined as 720 and up... it is no longer possible to get 100% financing through conventional means for 2nd homes or Investment properties....  and has pushed many well qualified borrowers into ALT-A borrowing to obtain their golas... which carries higher interest rates....

Overall lenders are becoming much more conservative in underwriting loans in 2007... 2006 was the worst year on record for early payment defaults(EPD) and shoddy underwriting...  Many wallstreet firms which collateralize much of this borrowing through warehouse lines has been demanding buybacks and instituting margin calls.  Many of these lenders cant afford the EPD buybacks or the margin calls and simply cease operations or file for bankruptcy protection.... 

Now more than ever it is important to know who you are doing business with to ensure that your loan will actually fund at the closing table... and that you work with knowledgeable brokers who can successfully navigate the troubled waters...

We estimate this climate will remain for much of 2007 and will eventaully stablize in the 2nd half of 2007...