Even as the housing supply began to exceed demand last year, builders kept sales brisk by pushing adjustable-rate, interest-only, and other risky loans.

By rushing into the mortgage business big-time, homebuilders helped fuel the US housing crisis. A diverse cast of characters combined to launch the once-in-a-lifetime housing boom of the past five years. Traditional mortgage companies and banks unleashed a barrage of loans, many to borrowers with iffy credit histories who didn’t bother to read the fine print about upwardly mobile interest rates.
As reported by Businessweek.com, Wall Street egged on the often-reckless underwriting by buying vast quantities of home loans for repackaging as securities. Now that the boom has fizzled and foreclosure rates are rising, the important role of large homebuilders as lenders is also coming into sharper focus.
In addition to spitting out subdivisions, many of which now stand half-empty, builders jumped into the mortgage business to a degree they never had. Wall Street provided the same encouragement it offered other lenders. Even as the housing supply began to exceed demand last year, builders kept sales brisk by pushing adjustable-rate, interest-only, and other risky loans.
In some cases they attracted clientele who couldn’t afford conventional mortgages. In others, builders allegedly violated federal lending standards to get customers to sign on the dotted line. KB Home (KBH) paid a record $3.2 million settlement in July, 2005, to resolve allegations by the Housing & Urban Development Dept. that the builder’s mortgage unit overstated borrowers’ income, among other practices, to obtain loan approvals. KB, which denied wrongdoing, sold its loan business before settling.
“Homebuilders really started to push these more aggressive mortgages down the throats of potential buyers to boost sales,“ says G. Hunter Haas IV, who as head of mortgage research and trading for Opteum Financial Services (OPX) had an insider’s perspective on the proceedings.
By early this year, Opteum’s home-loan business was going sour. The investment banks and their clients were rejecting builder-originated loans as too shaky and likely to go into default, Haas explains. Some homes were turning out to be worth less than builders had claimed, and some borrowers didn’t have the income noted on applications.
Until the market turned, the growing heft of the largest developers made it easier for them to obtain Wall Street financing for their mortgage businesses. Once dominated by modest local firms, the industry in the past two decades has seen the emergence of sizable publicly traded corporations such as Pulte Homes (PHM), Lennar, and Centex (CTX), each of which has a market capitalization of $7.5 billion to $8.5 billion. The 10 largest builders together had revenues of $98.8 billion last year, up from only $9.3 billion in 1992.
Busy developers that provided Wall Street with equity-underwriting business discovered they had friends in the investment banking world. “Once builders got larger and a little bit more predictable, they were able to borrow money from various credit markets, borrow from Wall Street, and expand more easily,“ says Thomas W. Smith, a building industry analyst with Standard & Poor’s Equity Research, which like BusinessWeek is owned by The McGraw-Hill Companies.
Now the bust is taking a brutal toll. In January, industry analysts predicted that the 10 biggest builders would have average earnings per share of $3.69 for 2007; the latest forecast is for a loss of $1.18.
Sheer overbuilding, a symptom of every housing bubble, is the most obvious explanation for the new ghost towns sprinkled around the country. But increased builder lending helped feed the trend. Statistics are scarce because developers don’t break out their lending revenues, but some analysts track “capture rates,“ or the percentage of home sales financed by builders themselves.
By the time marginal buyers fall behind on their payments, the builder has usually sold off their loans to Wall Street. But the human fallout can be found in neighborhoods around the country.

Greetings from Coolum, Australia, where APEC finance ministers just wrapped up a most illuminating meeting.
APEC refers to the Asia-Pacific Economic Consternation forum, the Asia-Pacific Economic Cooperation forum. While it really does mean the latter, the former name better represents what the 21-member group has become.
According to Bloomberg.com, Asia-Pacific nations like to think they work together. Yet if this year’s finance ministers’ meeting highlighted anything, it’s that as much as Asia-Pacific nations say they’re cooperating, they’re standing very much alone.
It illuminated how the US still blames Asia for saving too much and holding down currencies. Asians blame the US for saving too little and relying too much on Asia’s money. Japan criticizes China for an undervalued currency, while South Korea is stepping up criticism of Japan for the same reason. China is perturbed that it’s being criticized at all.
APEC’s gathering unfolded amid increasing volatility in global markets. One heard more consternation over who’s to blame for imbalances than how to fix things. And Henry Paulson’s decision to blow off the event was a bigger problem than the US Treasury secretary may realize.

Asian Irony
It has to be one of the biggest ironies in global finance. Ten years ago, it was contagion from Asia imperiling the global economy. For months after Thailand devalued its currency in July 1997, US officials reassured markets that Asia’s woes were containable. Once the Dow Jones Industrial Average began plunging several hundred points in a day, investors knew better.
Eerily familiar noises are coming from Paulson these days. In Beijing last week, he said the US economy is healthy enough to weather ongoing market declines. One hears similar reassurances from top economic officials near and far.
Yet Paulson’s confidence in an economy facing the worst housing recession in 16 years and massive current-account and budget deficits isn’t reassuring. It smacks of deepening denial at a time when policy makers like Guinigundo say the risks of contagion can’t be downplayed.
Asia has come a long way since 1997, as Asian Development Bank President Haruhiko Kuroda explained in Coolum. Banks are far more stable, currency reserves have been amassed, and governments are modernizing and integrating financial systems.

Decoupling From US
There are many risks to consider, but Asia seems able to handle it, Kuroda said.
Asia’s post-crisis recovery is a work in progress, though, and one shouldn’t overstate the extent to which Asia has decoupled from the US economy. While Asia’s rapid growth and booms in both China and India mean it’s less reliant on the US, the region isn’t ready to live without US demand.
The hedge fund angle also offers another bit of irony. In 1997, they were blamed for the speculative attacks on Asian currencies.
By 1998, the resulting volatility even claimed a weighty casualty: John Meriwether’s Long-Term Capital Management. Yet memories are short in the age of financial globalization and the years to follow were banner ones for aggressive investors. Asia alone has seen an exponential increase in the number of hedge funds since 2002. Now that trend is being tripped up not by events in Asia, but the U.S.

A New Contagion
Australia is on the front lines of how problems in the US are spreading to Asia. On Aug. 2, shares in Macquarie Bank Ltd. fell the most in five years after Australia’s largest securities firm said investors in some of its funds may lose as much as 25 percent of their money. Taiwan Life Insurance Co. stock had its worst week in over three years amid hedge fund losses.
It’s one thing for Bear Stearns Co.’s hedge funds to get slammed by the subprime mess; it’s another for casualties to begin piling up a world away. The Morgan Stanley Capital International Asia-Pacific Index plunged 3.9 percent in the five days ended July 27, the worst weekly drop since July 2006.
It’s a breathtaking role reversal. Just as Asia downplayed the odds of its 1997 contagion oozing around the globe, the US claims its problems are containable.

Increasingly sophisticated clients are demanding ever higher standards from their transition management teams.
Complex portfolio alterations require specialist knowledge across numerous fields, and pension funds, asset managers and insurance firms are increasingly looking for a transition manager to handle the process. It is a cost-effective way to make major changes in assets or structure, and that cost is going down rapidly as the transition management market becomes more competitive, reported Gfmag.com.
Struan Malcolm, head of transition management sales at ABN AMRO, says the market is growing exponentially, with new segments of the investment community looking to take advantage of what transition managers can offer.
One region that is seeing substantial expansion in the use of transition management is Europe. “Certainly in Europe the regulatory environment is driving growth,“ says Malcolm.
The numerous regulatory changes for pension schemes and asset managers in the United Kingdom, for example, are creating much change in the way that funds are managed. The long-term effects remain to be seen, but one thing is sure: The complete overhaul of the pension system has created much business for transition managers.
In addition, British Energy is considering adding a proportion of active management to its £2.45 billion British Energy Generation Group fund and may shift assets to provide better asset and liability matching for its £55.4 million British Energy Combined Group fund. Mercer Investment Consulting is advising the trustees.
In addition, many pension funds are changing not just asset allocation but also how they are structured. Tim Wilkinson, managing director and global head of transition management at Citi, adds: “Part of the reason for the ever-increasing growth in transition activity is that in addition to all the traditional themes--there always are some funds underperforming or changing asset allocation--a variety of structural factors are also in play, which are contributing to further demand for transition management services.“
Wilkinson also points to increased consolidation of both asset managers and pension funds to enhance productivity or improve member services. “In an era of sustained low inflation and correspondingly lower nominal returns, allied to a sharp increase in the regulatory regime, fund trustees and other guardians of assets are being held more accountable and taking more responsibility for all aspects of fund activity, and especially for managing ’gap risk’ to preserve performance,“ he says.
As a result of accounting and legislative changes, as well as stock market conditions, pension schemes are under increasing pressure to match assets to liabilities, diversify portfolios and maximize returns on investment. And increasingly they are turning to transition managers to help with that process.
There are a number of important factors to consider in choosing a transition manager, and sometimes it can be difficult to distinguish between the capabilities of different providers. As more players enter the market, it is increasingly important to ensure transition managers can deliver on promises and have the track record to prove it.
In addition, conducting proper due diligence is essential. “Understand every aspect of the provider’s set up and service--their track record, systems and people,“ advises Wilkinson. “Seek clarity on fees and ensure all potential conflicts of interest have been adequately dealt with. Insist on references.“
While conflict of interest has been much in the spotlight in recent years, according to some transition managers this issue is over-played. “Every provider has potential conflicts to address, regardless of model and whether a fiduciary or not,“ explains Wilkinson. “A fiduciary just has less.“
Thus, according to Wilkinson, selection of provider must not be overly focused upon the level of pre-transition estimates. “Various qualitative criteria should carry much greater weight in the selection process,“ he says.
“Transition managers that forecast low but deliver high, while being unable to clearly articulate that the variance was entirely unforeseeable and beyond their control, should be treated with great caution with respect to any future mandates.“