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Category Archives: Economy

The 2Q13 Economic Report is now available from here,

This report suggest that GDP growth is weak and a possible recession in 2015.


Appreciate your comments.

Below is the link to the 3Q12 Economic Report I wrote for a Colorado Bank’s Board of Directors and  (reproduced with permission):

Attached is the presentation I gave to about 35 business executives at TiE Rockies’ Business for Breakfast, yesterday morning Nov 30 2012. It was very well received.

Below is the link to the 3Q12 Economic Report I wrote for a Colorado Bank’s Board of Directors and  (reproduced with permission):

I’ve temporarily had to put aside QuantumRisk, since the data pricing was raised to $800,000 p.a., and now work for a bank. The link below provides the 2Q12 Economic Report I wrote for the  bank’s Board of Directors (reproduced with permission):

Here is the March 16th 20011 CREPIG podcast interview with JW Najarian & Robert Schecter. It has been described as ‘educational’.

This interview covers many topics, the economy, residential mortgages, commercial properties, distressed property industry, and especially methodology errors.

This interview is also available at the QuantumRisk website,

I hope you find this interview informative and an enabler to executing better investment decisions.


On a monthly basis QuantumRisk analyses more than 102,000 commercial properties with a total original appraised value of $1.5 trillion, backing more than 64,000 loans, with an outstanding debt of $680 billion, to report default rates, loss severity before recovery, loan to value ratio (LTV), debt service coverage ratio (DSCR), occupancy rates, cap rates & change in property appraisal value for more than 400 U.S. markets, by property type, by city, by MSA by state.

There are 5 types of CMBS Property Risk Analytics* reports:

1. CMBS Deals
2. CMBS Warehouse/Portfolios
3. CMPB Property Risk by City by State
4. CMBS Property Risk for a specific City
5. CMBS Property Risk for a specific MSA

There are 24 sample example reports of rigorous evaluations of the downside risk a CMBS Deal, Warehouse or Portfolio may be subject to given the current, this past month’s, economic conditions. These reports may be used to assess the potential upside risk. To keep your costs to a minimum QuantumRisk provides one-off reports for a specific set of deal / warehouse / portfolio requirements.

The reports are ideal for deal/bond restructuring, associating default risk to the bond stack, negotiating portfolio pricing based on today’s loss characteristics, and sub-optimal investment avoidance i.e. the portfolio may look great on paper but without an evaluation of the loss characteristics one may not be fully informed of the downside risks.

To purchase any of these reports, please conatct Ben Solomon.

*Property Risk Analytics is the registered trademark of QuantumRisk LLC.



Chief Executive Officer Mohamed El-Erian (Jonathan Alcorn/Bloomberg)

PIMCO Chief Executive Officer Mohammed El-Erian

Many economist (PIMCO, JPMorgan Chase) are now reporting that the economy will grow by at least 3% in 4Q 2011. In this month’s blog we take a look at historical quarterly GDP growth to determine whether this is realistic and what we could learn from all this.

We will use politically neutral time series analysis and transitions matrices to infer what the economy is capable of achieving all by itself, and that would form the base line of further inferences.

This analysis would suggest that there is no ‘new normal’.

Reporting GDP Growth

Real Gross Domestic Product, 3 Decimal (GDPC96)

Craig Brown in Seeking Alpha cautioned how one calculates & interprets GDP growth. For example, in the US annualized quarterly GDP is multiplied by 4 (4xQ GDP). This makes the annualized GDP much more volatile. While in UK it is the last 12-months.

The US Annualized GDP (4xQ) is more volatile than the 12-month Annual GDP. For example, starting with a 2Q 2009 GDP at 12,860.8, and 4 quarters of GDP growth of 1.23%, 0.92%, 0.43% & 0.63%, the Annualized GDP growth is 2.5% (=4×0.63%) while the Annual GDP growth across 4 quarters is 1.98%. Similarly, starting with a 4Q 2007 GDP of 13339.2, and quarterly growths of 0.15%, -1.01%, -1.74% & -1.24%, the Annualized GDP growth is -4.96% while the Annual GDP growth is -3.80%.

I prefer to use actual measurements, therefore my statistics will be Quarterly real GDP growth as reported by the Fed’s GDPC96, and Annual real GDP based on the last 4 quarters of GDPC96.

Borrowing some ideas from manufacturing process control, it is usually unadvisable to use a volatile metric to manage a process as it leads to the problem of over control. That is, more intervention than necessary leads to an unstable process that becomes even more difficult to control. The contemporary equivalent in economics is, are we in control i.e. expanding the economy or are over controlling, i.e. we printing money. This is not a question we can answer anytime soon. Only time will tell.

Random Walk GDP Growth
Probability Distribution of Quarterly GDP change (QuantumRisk LLC)

Probability Distribution of Quarterly GDP change (QuantumRisk LLC)

Lets look first at GDP as a time series whose change in Quarterly GDP is a random normal process. See Figure.

Analyzing GDPC96 shows that the GDP growth can be modeled by the Normal distribution N(0.88%, 0.80%).

Using this information to generate a Monte Carlo random walk to forecast GDP over the next 6 Quarters starting from 2Q 2010, provides a range of 4Q 2011 Annual GDP of between -1.24% and 9.41%, with a mean Annual GDP of  3.48% and standard deviation of 1.62%.

This is a surprise as a forecast Annual GDP of 3.48% suggest the possibility that both the PIMCO and the JPMorgan Chase model outcomes are not different from the random walk model.

Further, the range of outcomes, -1.24% to 9.41%, shows that there is no such thing as ‘new normal’. The concept of ‘new normal’ is derived from the concept of ‘regime change’, that the economy has substantially changed to a new level i.e. economic regime has changed, and therefore, the econometric models either need to be reworked or replaced. It is less about what the economy is doing and more about how existing models are able or not, to track the economy.

Transition Matrix GDP Growth

Quarterly GDP Transition Matrix (QuantumRisk LLC)
Quarterly GDP
Transition Matrix (QuantumRisk LLC)

The GDP Transition Matrix (above) was constructed from the GDPC96 time series. Starting at a 0.45% GDP growth (closest to 2Q 2010 of 0.43%), the transition matrix shows that the Quarterly GDP growth after 6 Quarters is most likely to be between 1.35% to 1.80% (5.4% to 7.20% Annualized). See Table below (not the complete table of results).

GDP Growth 0.00% 0.45%   0.90%  1.35%   1.80%   2.25% 2.70% 3.15% 3.60%
Probability    3.90%  6.07% 12.15% 21.68% 16.76% 12.05% 6.25% 5.51% 3.33%
of Growth

This is another surprise. The transition matrix shows that expected Quarterly GDP growth in 4Q 2011 is 1.43%. This is 60% greater than PIMCO’s forecast. The possibility of a Quarterly GDP growth of at least 0.9% (3.6% Annualized) is greater than 78%. That this method of estimating GDP growth is even more optimistic that PIMCO’s or JPMorgan Chase’s forecasts. Note, however that there is the 22% probability that this will not be realized.

Hyundai Motor Manufacturing (Mark Elias/Bloomberg)

Recovery Accelerating

What does all this mean? The forecasting techniques used in this analyses are politically neutral as they are based strictly on historical data. This would imply:

1. Per Bullard’s comments, that it is now much more likely that QE2 will be substantially reduced in 2011.

2. What is cause for concern is the possibility that modern econometric models are little different from random walk.

3. Most importantly, if my 4Q 2011 forecast turns out to be correct (we will know in 1Q 2012) it would suggest that the economy recovers at its own rate irrespective of what our elected officials attempt to do or don’t do.

4. Similarly, if the so called ‘massive’ intervention was of a sufficient amount, it should have produce a GDP growth that should be significantly greater than that of a random walk. This does not appear to be the case suggesting that the ‘massive’ intervention was not massive enough.

5. Arguably one could ask, should the government have intervened to save GM, AIG and the banking industry? Should not this intervention be the domain of the shareholders? And let market forces takeover. Yes, one could point to the potential phenomenal human costs had the government not intervened; but even with intervention we have an extended unemployment of about 10%. Therefore, weakening the case for human costs of unemployment.

Merry Christmas.



Guan Jianzhong, Chairman of Dagong Global Credit Rating Co. Ltd

Bloomberg reports that China’s Dagong Global Credit Rating Co. reduced its credit rating for the U.S. to A+ from AA citing a deteriorating intent and ability to repay debt obligations.

Having worked on both sides of the world, I have come to associate such statements with shortsightedness. My past experience as a senior research analyst for a brokerage firm in Asia-Pacific would suggest that we are going to see problems in China by 2012.

In this blog post we take a look at how consumers could cope with the Mortgage Mess. Yes, we need strong banks otherwise the Dagong rating will be fulfilled, but this economy is 70% consumer driven. We therefore need stronger consumers, as strong consumers underpin the health of the banks, and not the other way around. Using China as an example, as China’s income per capita rises its banks and financial services companies become more confident of themselves, therefore the Dagong ratings comment above. 

I want to inform our readers that QuantumRisk’s CMBS Property Risk Analytics promotion ended September 10, 2010 per an earlier newsletter. The new pricing, valid until March 2011, is available here.

Home Prices Sag in August 2010

The State of the Housing Market
In my August 2009 blog post Have we hit the Housing Bottom? I had suggested that the house prices will bottom in 1Q 2010. Given the graph, I must say that this was a pretty good estimate of timing. 

The second question I had attempted to answer then, was home price recovery sustainable? My answer at that time was that it was more likely not.

The economic analysis presented by HiddenLevers (see picture) suggests that house prices are struggling to maintain an upward momentum. 

Why? There are two reasons. First the glut in foreclosed homes (1 in 4 for sale are foreclosed) will keep supply substantially greater than demand. Second, 1 in 6 homes in foreclosure translates into 1 in 6 homeowners who will not be able to participate in homeownership for at least 7 years or a 15% reduction in demand.

The graph shows that house prices are now hovering in the 68% to 71% range of their 2006 peak values.  From an economic cycle perspective, the housing industry collapsed before the commercial property industry. Given a 15% reduction in residential ownership capacity, it is very likely that commercial property sector will recover before the residential sector does. That is, the trough in the residential sector will be longer than that of commercials.

What is not reported in the news is the residential vacancy rates. A friend of mine who works for a utility company told me a few weeks ago, this utility is seeing 1 in 7 homes vacant. This is 50% more than reported by US Census Bureau for 2Q. That means rental incomes will not increase in the medium term. It also means that utility revenues will fall by 14%.

Some other bank just increased the difficulty of Chief Executive Officer Brian T. Moynihan 'hand to hand combat' over mortgage disputes.

The Next Big Wave: Legal Risk
Most of us are focused on market, credit & operational risks, but the next big wave will be legal risk.

I recently found out that banks are selling the second mortgage on foreclosed homes to debt collectors. Sure this maybe legally possible but lets weigh the pros & cons. The pros. Maybe banks think they can get back they principal in the second mortgage by selling the second mortgage to a debt collector. Sounds great, high fives to the managers who thought up this one. And at worst you don’t even have to write it off your balance sheet just yet. Kudos.

But wait. Does anyone really think they can get their money back from homeowners who could not even pay their first mortgage? Especially if they are unemployed? It also raises another question, what was the function and scope of collateralization?

Now the cons. What this action has done is to clarify that in the event of a foreclosure / repossession, the bank recognizes that collateralized debt survives ownership and can be put back to owner / originators. (Check with legal counsel for an informed opinion.) In the United States one cannot have one set of laws for one group of people and another set for another group of people.

Therefore, investors who bought RMBS bonds can now recognize that their securitized bonds survive any asset ownership issues, and banks are now liable for securitized bonds because they survive ownership.

I found out about a bank’s access to your personal funds some years ago. When I contacted the FDIC about it they said they could not do anything about it. Some mortgage contracts include a single sheet document that states that the bank has the right to move your funds around to keep your mortgage current. This I believe is antithetical to the securities law because securities law does not allow financial services companies to move funds around for a client for the benefit of the company.

The problem here is given such a ‘contract’ will or does the bank have the right to reach out to your 401(k) or similar funds?

Prime fixed rate foreclosures jump

How Consumers Can Protect Themselves
There are several ways consumers can protect themselves from future messy mortgage problems:

 1. House Pricing: The graph above (picture in State of the Housing Market, above) suggests that with today’s market conditions a home buyer should consider as an upper limit a purchase price of about 70% of the 2006 appraisal. If the housing situation deteriorates, this 70% number will drop. Looking at CMBS for guidance, this number can get to be as low as 54%.

 2. Appraiser Selection: Before purchasing, get an appraisal of the property by an appraiser who does not have links to banks as this minimizes banker bias.

 3. Mortgage Origination: If you are purchasing a foreclosed property, it is not recommended that you get your mortgage from the same bank that foreclosed the property. Why? At least in theory, in the event that there are ownership issues, you have a different bank behind you. 

 4. Safeguards: Given the state of the housing market, it would be prudent for the home buyer not rush into a purchase as the housing market is not likely to recover anytime soon. If you do so, you would need to have staying power. Therefore, before making a purchase, here are some points you should consider:

 4.1 Title Insurance: Don’t sign an S&P if you cannot get title insurance.

4.2 Deposit: Make your deposit conditional upon getting a clean title.

4.3 Indemnification: Require that the seller and/or the mortgage provider accepts liability for any future ownership claims in the event of the failure of the title insurance company. The lesson of 2008 was that many securitized bond credit enhancements (credit insurance) turned out to be worthless when the economy as a whole turned south.

4.4 Survival: Require that in the event of a foreclosure/repossession that all collateralized claims (1st, 2nd & 3rd liens) cannot survive the ownership.

4.5 Delinquency: Require that the mortgage provider cannot start foreclosure proceedings until the mortgage is at least 90 days past due. In the state of Colorado there are no laws to prevent a lender from foreclosing on day 2. Yes, even I was surprised by this, and know of at least one recent case where the foreclosure proceeding was started on day 50. 

4.6 Miscellaneous Contracts: Do not allow the mortgage lender have access to your other funds. Remove all such ‘subcontracts’ from your S&P agreement.

 5. Walk Away: If there are any doubts about the price, property or claims on the property, walk away. This market in not going to recover any time soon, and there will be plenty of second chances.

 There are many really good managers in banks, but as a general rule banks rotate their managers. So the great manager you see today could be replaced by a rogue manager tomorrow. Therefore do not feel ‘uncomfortable’ including these conditions in your S&P. You may even have to hire your own legal counsel to protect yourself. Remember it is wiser to walk away then to be burdened by a debt for a property you no longer own.

The real sad story is that we will eventually see 1 in 6 families homeless. To put things into perspective, James Fry, founder of Mean Street Ministry, reports that when he started this ministry about 10 years ago, there were 2 suicides per year, today there are 2 a week. We as a family have known James Fry, his family & his ministry for many years. Let us in Thanksgiving help someone in return.


Disclosure: I’m a capitalist too, and my musings & opinions on this blog are for informational / educational purposes and part of my efforts to learn from the mistakes of other people. Hope you do, too. These musings are not to be taken as financial advise, and are based on data that is assumed to be correct. Therefore, my opinions are subject to change without notice. This blog is not intended to either negate or advocate any persons, entity, product, services or political position. Nor is this blog post to be construed as investment advice. 

Contact: Ben Solomon, Managing Principal, QuantumRisk

Real Problem versus Many Perspectives 
The perspectives reported on the Mortgage Mess varies very widely. From the political right is the Wall Street editorial “We’re not aware of a single case so far of a substantive error” to the political left Congressman Alan Grayson’s “the easiest way to make a buck is to steal it”. This one really shocked me, financial institutions and their mortgage servicing departments hired hair stylists, Walmart floor workers and people who had worked on assembly lines and installed them in “foreclosure expert” jobs with no formal training.

In my opinion these are details that subtract from the big picture. Without understanding the big picture we would not have a context in which to address this Mortgage Mess.

What is the big picture? It is, is our fiduciary responsibility to our shareholders or is our fiduciary responsibility to our customers? Correct picture but wrong perspective.

Our fiduciary responsibility is to our shareholders and that this fiduciary responsibility is derived from our fiduciary responsibility to our customers. We’ll discuss each perspective below.

Residential Mortgage Industry is Shrinking
First some context to this discussion. From the Wall Street reported data I estimate that 15.4% or about 1 in every 6 US homes are in foreclosure, and this does not include recent past foreclosures. That is a huge amount and bank troubles pale in comparison to this number. What does this number tell us?

It says that the mortgage market size will shrink by 15% as foreclosures are executed because foreclosed home owners will be barred for at least 7 years from participating in this market. The lowest estimate I was able to find was 10%. Therefore to remain profitable banks will have to lay off at least 15% of their residential mortgage staff.

Further, as reported in the New York Times, if title companies shy away from insuring foreclosed properties because they think those properties are vulnerable to claims, this will further depress the market, as investors too will shy away. 

Looking at the CMBS industry for clues, even though the reported commercial property appraisals are hovering in the 55% range, the anecdotal prices I have heard suggest purchase prices averaging between 10 to 20 cents on the dollar, and there are no reported foreclosure problems. Therefore, we can infer that the residential mortgage industry will experience similar appraisal versus selling price discrepancies and is therefore not out of the woods, yet.

Good News for Banks?
The Florida attorney general’s office says it doesn’t have the power to investigate banks but it has started an investigation into the law practices. To complicate matters, one needs to be aware that there is a difference between industry practice and actual mortgage regulation. There are also enormous variations from state to state with respect to foreclosure procedures. I found that in one state banks can start foreclosures on day 2 (1 day delinquent). This means that even though the 50 State Attorney General’s offices have launched investigations into the mortgage industry, in my opinion the banks don’t have to worry about them as these offices have no teeth. But some how this does not sound like good news, right?

First Fiduciary Responsibility
This Bloomberg article very nicely summarizes the current Mortgage Mess. That there are two fronts, “against U.S. homeowners challenging the right to foreclose and mortgage-bond investors demanding refunds that could approach $200 billion”. Of course this is an evolving situation and it is very likely many more fronts will open up.

The first fiduciary responsibility is to your customer. This is very clear in the many securities regulations since 1933. Of course banks are governed by banking regulations and in many instances are exempt from securities regulations as these exemptions are covered in the banking regulations.  Therefore I wonder if the banking regulations are any where nearly as concerned about protecting bank customers as the securities regulations require of investment advisors and broker-dealers?

Though the individual contracts appear to be in favor of the banks, investors are using every means possible to force banks to buy back bad mortgages. The final outcome, however, may play out in terms of power of buyers versus power of sellers, and not through legal means. That is investors in the future will seek assets from players who are amenable to buy backs than from those who are not.

This may be a good thing for the economy as insufficient principal protection may cause investors to seek alternative investments such as manufacturing, R&D driven technology licensing, and new materials, to name a few. Why? Because residential mortgages are no more safer than R&D.

Therefore, why did the residential mortgage market develop to the size it did? I can only conjecture that the existence of GSEs led to the mistaken belief that residential mortgages were one of the safest forms of investments.

Second Fiduciary Responsibility

The second fiduciary responsibility is to shareholders as this is a derivative of the fiduciary responsibility to customers. It is in this context that one would ask the question, how did this Mortgage Mess come to be?

In this context, given the Wall St. crash of 2008 and in the light of the Goldman Sachs hearings, the Wall Street editorial opinion that “We’re not aware of a single case so far of a substantive error” is difficult to justify as this would raise other questions.

As a general rule organizational seniority and salaries increase with fiduciary responsibility to shareholders. Therefore the questions, why did we did not have in place the systems and procedures to detect “substantive error”? Why were we paying managers so much if they did not know what was happening? What were these managers thinking?

Quite obviously operational risk and credit risk methodologies were insufficient. And may be they were ignored? A rethink of these methodologies and how risk committees are staffed and to whom they report to is in order.

Some Likely Future Outcomes

In the context of the First Fiduciary Requirement we can infer some future outcomes. 

Firstly, if there genuinely were mistakes in the foreclosure process, the second lien holder should now have a claim to the funds recovered from the sale of the property as the first lien holder did not conduct his fiduciary responsibility correctly. (Check this with your attorney as he may disagree.)

Second, title insurance fees may increase. Title insurers have two options either do not insure the title or substantially increase the fact checking required. The latter will increase title insurance fees. Assuming that Congressman Alan Grayson’s findings are correct, I believe that title insurance firms will choose not to insure as it would be more expedient to not insure than to dig up bad documents. Therefore, don’t expect title insurance for foreclosed homes unless the bank owns the title insurance firm, but this should raise questions of bias. My guess is that the title insurance problem is only going to get more complicated.

Third, future bank purchases will be structured more like an asset sale than an acquisition or merger. Why? First you don’t absorb the bad management team. Second by insisting only on asset purchases you put into place a screening process that substantially ensures that you are not purchasing a barrel of bad apples. Sure its a lot of work but that comes back to the banks’ fiduciary responsibility to its shareholders. An asset sale would allow the purchaser to include a clause that any future claims due to fraud, misstatement or omissions are the liability of the seller’s management team. Therefore one can infer that Bank of America’s purchase of Countrywide as a single company was not a good strategy, and that any subsequent M&A activity in the banking sector would require a rethink.

Fourth, further changes to securities regulation. Dodd-Frank indeed may turnout to be insufficient or in the worst case irrelevant as private action against mortgage industry participants further tighten regulation. For example if we assume that the alleged wrong doings were conducted by a handful of employees and not an issue of management culture, checks and controls, then we can expect changes to portions of the securities and banking regulations that would provide investors more time to seek recourse. For example Securities Act of 1934, Section 10(b), investors have two years from discovery of the fraud or five years from when it occurred to file their claim, while Sections 11 and 12(a)(2) claims against misstatements or omissions must be brought within one year of discovery and three years of the securities filing. These timing could be changed to 10 years or simply no statue of limitations for any fraud, misstatements or omissions.

Fifth, we would expect bond investors require,
1) A buy back clause in any future securitization, and that buy back clause is automatically transferrable to any and all future bond holders. At the very least in the event of the failure of the insurance provider.

2) That any third party providing a fee based opinion about a or soon to be securitized deal state that they have fully examined the collateral backing the deal.

This downside risk assessment of the residential mortgage industry suggest that an end to the industry turmoil is not in sight. Further, we can expect substantial private sector initiated changes to investment contracts that will provide both investors and home owners with better uniform protection.


Disclosure: I’m a capitalist too, and my musings & opinions on this blog are for informational / educational purposes and part of my efforts to learn from the mistakes of other people. Hope you do, too. These musings are not to be taken as financial advise, and are based on data that is assumed to be correct. Therefore, my opinions are subject to change without notice. This blog is not intended to either negate or advocate any persons, entity, product, services or political position. Nor is this blog post to be construed as investment advice. 

Contact: Ben Solomon, Managing Principal, QuantumRisk