The fisherman know that the sea is dangerous and the storms terrible, but they have never found these dangers sufficient reason for remaining ashore - Vincent van Gogh (1853-1890)

As you all know, I am an inside subprime wholesale sales rep.  So, I don't get out to call on offices.  Of course, it doesn't help that my ankle bracelet goes off as soon as I leave my office - and then, my PO is on the phone asking where I am.  So, I am 'bound' to my office.  The business has changed radically over the past 6 months as we all are 'fishing' more each day; I am dealing with twice the number of broker offices, than in the past, just trying and be where I was in loan production last year.  Sound familiar?  I imagine you are in the same spot, in the same boat.

Why are we in this boat?  There was alot of fancy financial engineering during the credit boom years.  The architects of these esoteric mortgage instruments, in my mind, barely understood by the Wall Street Wiz quant kids that created them; and then Wall Street peddled their trash to the world.  I have no pity for Wall Street.   As a free market advocate, they deserve what they created, and now have foreign partners in bed with them.  Many in our industry don't understand the loan products and derivatives created by Wall Street, but we are certainly suffering the effects.  Investors were struggling with the same questions and relied on the credit agencies ratings to confirm and comfort there decisions to buy the pools of subprime residential mortgages, Alt A mortgages, commercial loan portfolios, municipal bonds, in fact all debt securities - and now are suffering the 'Moody's Blues'  - S&P, Moody's and Fitch are the major credit rating agencies in the US  The Securities and Exchange Commission designates 'Nationally Recognized Statistical Rating Organizations' (NRSRO), and requires that to comply with net capital requirements banks have to hold only assets rated by the NRSRO's, to avoid running afoul of Fed regulators.   This means many pension funds and money managers are restricted to only owning the highest-rated securities, AAA - so when ratings are cut, it creates more selling pressure as many investors are forced to sell into a declining market.  And, like us, once you are 'burned' on an investment for hundreds of millions, or billions, you are going to be extremely cautious about putting money back into where you just got your clocked cleaned - if you ever will?

The problem, but there are many, with this game is that if the statistical models cooked up by the Wall Street self-proclaimed genius don't work then the cookie crumbles.  So, the Wall Street banks have some of the blame, and their earnings are being eaten up faster than a 'Pac-Man' can move.  However, the rating agencies are more to blame, in my opinion, as they provided the branding iron to label the beef 'AAA'.  Once it was discovered that the underlying performance assumptions were closer to Disneyland numbers, we all saw massive downgrades in the hundreds of billions in subprime and Alt A loans, which caused credit dislocation and the crisis that we are still living with today...... and will continue to live with for some time yet to come.  At least until everything is written down to its 'real' value.  The markets general reaction is a move back to 'vanilla' financing - the frosting is off the cake, no more exotic decorated products - and much less faith in the 'opinions' of a rating agency before an investment decision is made. 

When Is It Going to Improve?  What is now happening behind the 'Wizard of Mortgage Oz' curtain?  There was a recent conference in, my favorite town, Las Vegas 2 weeks ago - the American Securitization Forum.  There were 24 major investors in attendance discussing the 'when' will there be a secondary market and what loan products they would buy individually.  There was no interest in any ARM products and even less interest in any stated loans or NOO properties.  So, we no longer offer a 3/27 ARM - now only a 5/25 and fixed rate.  In addition, we will no longer offer a 'stated product SIVA.'  We still offer a stated product, MVP, which requires a 0x30 the last 18 months.   So, if you are going SE stated, you now need a 580 and a 0x30 the last 18 months - plus you must have at least 2 months PITI sourced and seasoned for 60-days.  Without a secondary market for loan securitizations, rules change - and will continue to change until loan performance improves.  As a lender, we can't 'manufacture' a loan product if there are no buyers, or we would be out of business.  The only way the secondary market is going to come back is when performance exceeds expectations and as a lender, we must make loans where the prospects of the loan contract being repaid has a high degree of confidence because mortgage investors require it to be back in the 'game.'.  Otherwise, we would join the non-exclusive club of 200+ lenders that have gone bankrupt.  At this point, we are 1 of a very few subprime lenders left on the playing field.    But this is what happens when a credit bubble bursts, the guilty and innocent are punished.

Housing  Not sure when there is going to be good news out of this market, unless you have a strong borrower looking to purchase or do a refi.  Looking at home prices-to-income (affordability index) or price-to-rents, I expect prices having to drop 15%-20% for the market to get into balance.  If you are sophisticated, you could hedge this by selling a housing futures contract, so if prices continue to decline, your 'short' housing contract would rise in value - but this approach is a bit long in the tooth. 

Negative Equity  Sales of previous owned homes fell 21% in the 4th qtr for a year earlier.  Prices declined in 77 out of 150 metropolitan areas, according to the NAR.  As prices fall and homeowners realize they owe more on their homes than it is worth its provides an incentive to walk.  In Las Vegas, half the homes for sale are vacant.  Where the app said 'owner occupied', it turned out to be an investor hoping to buy and flip - and now it is buy and die.  Goldman Sachs Chief Economist expects home prices to slide 10% nationwide in 2008, meaning 15 million mortgages, 30% of all outstanding, will be attached to negative equity.  That implies about $3 trillion worth of moorages could be worth more than the homes they finance.  Very scary numbers.

The National Association of Home Builders after pumping $1.4 million  into Congressional campaign coffers found out that it was left out of the stimulus package.  They were expecting to be able to apply current losses to taxes paid and get a refund.  When this provision wasn't in the stimulus package, they announced this past wee,k while at their annual convention in Orlando, that the purse strings were closed 'until further notice'.  Seems the contributions were, in fact, defacto bribes, and when there was no pay off, then no more moola to political campaigns.  .As good businessmen, they expected a return on their investment and the contributions had nothing to do with the 'best' candidate.  Now that is a surprise?!  

Predicting how much worse the US housing market will get is tough.  I offer my opinions, and you have yours.  We all know the future is uncertain and getting a clear picture is hard.  The reason being is that you can defend your position - bull or bear - using a number of different benchmarks.  If it is confusing to us in the industry, then pity the concerned homeowner who frets about the value of what for many is their single largest asset.  You can look at 3 different measures of housing prices - and none of them perfect.

Office of Federal Housing Enterprises Oversight (OFHEO) relies on data collected by Fannie and Freddie, which OFHEO regulates (they also offer an on-line home price calculator at http://www.ofheo.gov/calculator/ - which I tried using my own home by selecting 'MSA', and if I could sell my home for the price listed, I would be moving now to Costa Rica).  Then you have the S&P Case/Shiller index which looks at 20 major housing markets (the index off which you can go long or short housing prices on the futures exchange).  And lastly, the NAR median home price - which reflects the mix of homes actually sold in a given month as well as the change in prices.

OFHEO index says home prices ROSE nationally by 1.8% between the 3rd qtr of 2006 and 2007.  The S&P Case/Shiller national index was down 4.5%.  The NAR measure fell 6%.  So, what do you believe?  I am having the same problem as I try to view the pieces of the puzzle.  However, as mentioned above, I believe home prices have to decline more to attract borrowers because we have lost the marginal buyer/or refi as credit guidelines have tightened over the past year.  Throw in housing inventory levels at almost 10 months of supply and the pressure on home prices is intense.

Credit Markets  Credit default swaps, CMX, derivatives, leverage buyout bonds (LCDX), synthetic positions, tender option bonds, auction rate debt, CMO - seems you need a financial dictionary when you read the papers.  The contagion continues to roll.  For collateralized debt obligations (CDOs) that were stuffed into Structured Investment Vehicles (SIVs) financed by asset backed commercial paper (ABCP) with subprime loans at its core is one thing but the credit crisis has spread to other debt securities with strong credit backing.  This past week, another custom made Wall Street product,  auction rate securities(ARS) - which are usually long-term bonds with interest rates that reset periodically (usually once a month) at an auction - and are favored by municipalities, museums and other tax-exempt institutions, offered investors an instrument that was supposed to be as liquid as cash, with better returns. But liquidity depends on weekly or monthly auctions, and last week 1,000 of these auctions failed due to lack of buyers. This was an unprecedented Whoops in a $330 billion market  The potential liability to banks that pushed the investment vehicles is that they will have to absorb them on their weak balance sheets.  These were were pitched as cash equivalents and the banks may be held responsible for losses and the clients' inability to get their money out.   This past week the Port Authority of Ney York and New Jersey just saw their interest rate jump to 20% from about 4.2%, when bidders didn't show up for the auction, which means their interest payments jumped from $83, 611 to close to $390,000.   Same thing happened to the City of Reno as the interest rate they now have to pay zoomed to 15%.   Ditto for the State of Wisconsin as it say its rate jump for 4.75% to 11.5%.  These are just a couple of examples out of hundreds of auctions that fell apart.  Why?  It wasn't due to fear they would default, but the worry that further market turmoil could undermine future auctions leaving them unable to sell the bonds to someone else if the bond insurers backing the bonds can't back up the guarantee - which would reduce the market value of the bonds. 

Why has a crisis that began with loans to a limited group of home buyers ended up disrupting so much of the financial system? Because, ultimately, it's more than a subprime crisis; indeed, it's more than a housing crisis. This is a crisis of FAITH - what started with subprime mortgage loans, than lead to CDOs, then to SIVs, then ABCP, then to credit ratings, and then on to credit insurers, then to municipal bonds......... a snowballing lack of investor confidence in any credit/debt products that Wall Street banks are peddling.   If not AAA gov't bonds, then the interest in zip.  No credit markets are totally safe from the rolling fireball of worry, until it finally burns itself out.

There is an increasing number of exotic leverage loans - the kind used to refi recent corporate buyouts - that are trading like junk bonds.  Standard and Poor's said its index of prices on corporate leverage buy out loans fell to a record low of 86.28 cents on the dollar at the end of last week.  There remains credit stress and we all should expect continued volatility as risk is re-priced.  It will take time for evidence in the creditworthiness and robustness of financial institutions.  As ugly as it is, this is a necessary condition for the re-establishment of adequate market liquidity.  Or, so the bank hope, that are still sitting on a mountain of leverage loans they underwrote and can't sell into the marketplace.  Individual investors have also left the market according to AMG data released last week which showed that investors pulled their money out of bank-loan mutual funds for the 18th straight week - an exodus that has withdrawn $4.26 billion from the market.  As business slows, it means greater competition for projects and lower profit margins.

Loans, like the financing for Delphi Corp (GM parts manufacturers) to exit from Chp 13 Bankruptcy are finding it very hard to secure, even though promised months ago.  Banks are sitting on bond underwriting obligations and they want them off their books as they tie up precious capital.  The Wall Street banks are trying to 'shop' the loans daily (and there are hundred being shopped around for investor interest) - the response from leery investors is a loud Bronx cheer.  'We don't want them!'  The credit markets, beyond just Alt A and subprime, but also the corporate credit market is seeing 'no bids' when they are offered.

Ben & Hanks Valentine Day Talk  Fed Chairman Ben Bernanke and Treasury Secretary Henry Paulson appeared before a Senate committee yesterday and offered up testimony on the economy, housing, and financial markets. Depending on the question asked, who was answering, and which paper interpreted, they were pessimistic or optimistic, confident or timid, engaged or apathetic. Ben said, 'the outlook for the economy has worsened.....and downside risks to growth have increased.'  The financial papers agreed, however, that more rate cuts are likely — but if you watched the testimony many of the senators didn't like what they heard from the dynamic duo - and the Senator from NJ really busted their chops.  Mr. Paulson and Mr. Bernanke seemed bored at the hearing. The highly caffeinated senators on the panel all had venti Starbucks cups in front of them, and (Nebraska Republican) Chuck Hagel had a grande size — but they proved unable to excite the witnesses. While panel members cited the words "storm" and "crisis" in assessing the state of the economy, Mr. Paulson leaned back, draping his left arm over the back of his chair. Bernanke looked down, admired the chamber's marble walls and stroked his beard.  I thought Batman and Robin understood, from watching the 'Mortgage Weather Channel', that there was still a sh*t storm out there, but now I wonder.  It is not the cost of credit that is the problem, but its availability, or lack of it.

Treasury Markets  The Fed funds futures market is discounting a 50 bps rate cut in the current 3% target rate by the time of the March 18th FOMC meeting  As the yield curve increases it sends a msg that if there is a recession (which as I have said, I believe we have been in since Oct) it will be of limited duration.  .

Yield Curve  The positive slope in the 2-10 curve is a good sign, but we are likely to see some more bad news first.  Banks are holding alot of assets on their balance sheet at losses so they remain careful about how much they lend and at what cost they're lending it.  The 2-yr dropped 2 bps last week, as the 10yr increased 11 bps, which increased the 2-10 spread to 185 bps vs 171 the week prior as concerns about the inflationary potential of the fiscal and monetary stimuli being applied to a flagging economy.