The 2Q13 Economic Report is now available from here,
http://www.QuantumRisk.com/PDF_Files/4Q12EconomicUpdates(2013-01-09)-Public.pdf
This report suggest that GDP growth is weak and a possible recession in 2015.
Appreciate your comments.
The 2Q13 Economic Report is now available from here,
http://www.QuantumRisk.com/PDF_Files/4Q12EconomicUpdates(2013-01-09)-Public.pdf
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):
http://www.QuantumRisk.com/PDF_Files/4Q12EconomicUpdates(2013-01-09)-Public.pdf
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. http://www.QuantumRisk.com/PDF_Files/AreWeGoodStewards(2012-11-30)TiERockies.pdf
Below is the link to the 3Q12 Economic Report I wrote for a Colorado Bank’s Board of Directors and (reproduced with permission):
http://www.QuantumRisk.com/PDF_Files/3Q12EconomicUpdates(2012-10-12)-Public.pdf
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):
http://www.QuantumRisk.com/PDF_Files/2Q12EconomicUpdates(2012-07-18)-Public.pdf
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, http://www.QuantumRisk.com/.
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.
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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
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.
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
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.
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.
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.
Summary
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.
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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
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