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Pick your poison..................

U.S. Recession Is Now an Even Bet as Spending Slows

Feb. 8 (Bloomberg) -- A U.S. recession is now an even bet as job losses and the housing contraction jeopardize the longest- ever expansion in consumer spending, according to a Bloomberg News survey.

The world's largest economy will grow at a 0.5 percent annual rate from January through March, capping the weakest six months since the last economic slump in 2001, according to the median estimate of 62 economists polled from Jan. 30 to Feb. 7.

Federal Reserve Chairman Ben S. Bernanke will lower the benchmark interest rate a further half point by June, adding to the fastest easing since at least 1990, the survey showed. The odds of a recession over the next 12 months, pegged at 40 percent in January, jumped as payrolls, auto sales and stocks slumped.

``We're seeing a real squeeze on the consumer,'' said Kurt Karl, chief U.S. economist at Swiss Re in New York, the world's largest reinsurer. ``We're in, or on the brink of, a recession. The Fed will keep cutting rates to help it be a short and shallow one.''

The anticipated rate of expansion for all of 2008 was reduced to 1.7 percent, the lowest in six years. Economists also slashed the projected growth rate for the second quarter to 1 percent from the 1.8 percent forecast last month.

Consumer spending, which accounts for more than two-thirds of the economy, will grow at a 1 percent annual rate from January through March, half the previous quarter's gain and the smallest since 2001. The last time spending dropped was in 1991.

`Cusp of a Recession'

``We're on the cusp of a recession,'' said Stephen Stanley, chief economist at RBS Greenwich Capital in Greenwich, Connecticut. ``Support from the labor market is starting to erode. The consumer is definitely in for a period of weakness.''

Stanley is among a growing number of economists who project spending will fall at some point this year. The last recession was from March to November 2001, according to the National Bureau of Economic Research. The Cambridge, Massachusetts-based group is the official arbiter of American business cycles.

The economy lost 17,000 jobs in January, the first drop in more than four years. The unemployment rate will gradually rise to 5.2 percent by the second quarter of 2008, according to the survey median, from last month's 4.9 percent.

Five of the top six automakers in the U.S., including Ford Motor Co. and Toyota Motor Corp., posted a drop in U.S. sales in January, reinforcing forecasts that industry sales will fall this year to the lowest since 1998.

`Drying Up'

``If the job market is drying up, which seems to be the case, consumers have nothing going for them,'' said Joshua Shapiro, chief U.S. economist at Maria Fiorini Ramirez Inc. in New York.

Big-ticket items aren't the only ones taking a hit. Retail sales at stores open at least a year rose 0.5 percent last month, the worst January since 1970, the International Council of Shopping Centers said yesterday. Discounts failed to avert declines at chains from Target Corp. to Nordstrom Inc.

``It is a difficult retail environment out there, and I expect it will be going forward,'' Terry Lundgren, chief executive officer of Macy's Inc., the second-biggest U.S. department-store chain, said this week. The retailer cut its fourth-quarter profit forecast and said it will eliminate 2,300 jobs.

Worsening Housing Scene

Meanwhile, the housing industry is bracing for even worse times ahead. The National Association of Realtors yesterday cut its 2008 forecast for sales of previously owned and new homes.

In a sign the slowdown is spreading beyond housing, service industries unexpectedly contracted in January at the fastest pace since the 2001 recession, a report from the Institute for Supply Management showed on Feb. 5. U.S. stocks tumbled the most in 11 months that day. The Standard & Poor's 500 Index is down for three consecutive months, the longest losing streak since 2003.

Richmond Fed President Jeffrey Lacker said this week he sees ``the possibility of a mild recession,'' and further rate reductions may be needed.

San Francisco Fed President Janet Yellen said yesterday the U.S. economy will probably avoid a recession. She said the Fed's interest-rate cuts should help growth pick up later in the year.

Dallas Fed President Richard Fisher, speaking in Mexico City yesterday, also said the expansion was poised to return to its long-term trend in the second half of the year because of the rate cuts.

Rate Cut Forecast

Economists in the Bloomberg survey forecast the Fed will trim the benchmark rate by a quarter point to 2.75 percent this quarter. Investors are betting policy makers will do more and cut the rate by a half point to 2.5 percent on or before the March 18 meeting, futures trading shows.

The central bank cut the rate by 1.25 point to 3 percent over nine days last month, including an emergency move on Jan. 22, the fastest reduction since the federal funds rate became the main policy tool around 1990.

Bloomberg.com: Worldwide
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Exploding ARMs Roil Bernanke's Drive to Calm Markets

Exploding ARMs Roil Bernanke's Drive to Calm Markets

Feb. 7 (Bloomberg) -- Joe Ripplinger took out a $184,000 mortgage in 2006 and makes his payments every month.

Now he owes $192,000.

The 66-year-old Minneapolis house painter has a payment- option adjustable-rate mortgage. It allows him to write a check for $565 a month even though he owes $1,300. The difference is added to the mortgage, and when his total debt reaches $212,000, or after five years have passed, he said his monthly minimum could jump to about $2,800, which he can't afford.

``We're barely making it right now,'' Ripplinger said.

The estimated 1 million homeowners with $500 billion of option ARMs are beyond the help of interest-rate cuts by Federal Reserve Chairman Ben S. Bernanke. While subprime borrowers face an average increase of 8 percent or less when their adjustable- rate mortgages reset, option ARM homeowners may see their monthly payments double after their adjustments kick in.

``We call them neutron loans because they're like a neutron bomb,'' said Brock Davis, a broker with U.S. Express Mortgage Corp. in Las Vegas. ``Three years later the house is still there and the people are gone.''

Once option ARM borrowers' loan balances reach a predetermined limit, called a negative amortization cap, usually 110 percent to 120 percent of the mortgage amount, their payment rates immediately increase. They also automatically shoot up after five years. Otherwise, increases typically are capped at 7.5 percent of a borrower's initial payment per year.

One in Five

``These could be called long-fuse, exploding ARMs,'' said Kathleen Keest, former assistant Iowa attorney general and now senior policy counsel at the Center for Responsible Lending in Durham, North Carolina. ``I've heard people say they are the most complicated product ever offered to consumers. They are the real liar loans.''

The loans accounted for 8.9 percent of the almost $3 trillion in U.S. home loans made in 2006, up from 8.3 percent in 2005, according to an estimate by industry newsletter Inside Mortgage Finance. Originations of option ARMs fell 50 percent during the first nine months of last year, the newsletter says.

One in five option ARMs packaged into bonds last year required less than 10 percent down payment and no proof of a borrower's income, according to a Jan. 22 report by New York- based analysts at UBS AG, Europe's largest bank by assets. Two percent required no down payment at all from the borrower, the analysts said.

Better Scrutiny

Delinquency rates on option ARMs tend to be low in the early years, misleading some investors to think they will remain safe, said Sean Kirk, a debt trader at Seaport Group LLC, a New York- based securities firm focused on bonds of distressed or restructured companies.

Four types of home buyers typically get option ARMs.

Speculators, who plan to sell the property quickly, made up 12 percent of all option ARMs packaged into bonds last year, according to UBS. That included only borrowers who identified themselves as investors and not residents, who get lower mortgage rates. Wealthy people have used the loan for its flexibility, according to Thornburg Mortgage Inc. in Santa Fe, New Mexico.

The rest either took out the loans as an ``affordability'' product to buy more expensive homes, according to Standard & Poor's, or borrowers may have been misled about the terms, according to federal bank regulators.

Minnesota Legislation

``I never heard of a payment-option ARM before,'' said Ripplinger, the Minnesota borrower. ``We thought they were putting us on a 30-year fixed. They didn't put us on a 30-year fixed. I believe that's why a lot of people are losing their homes now.''

Borrowers who tapped home equity in refinancing represented more than 44 percent of the option ARMs underlying securities created in each of the past four years, according to UBS.

Minnesota passed legislation in August requiring mortgage brokers to act in borrowers' best interest, a law that may have made Ripplinger's mortgage illegal, said Brandon Nessen, executive director of Minnesota ACORN, a housing activist group in St. Paul.

``You can't make a loan that puts someone in a worse position than they were in before,'' Nessen said.

Sophisticated borrowers can take out option ARMs and avoid problems, said Ira Rheingold, executive director of the National Association of Consumer Advocates in Washington. It's just that mortgage sellers marketed them to people who didn't understand the terms and couldn't afford them, he said.

`Cheat People'

``It was used to cheat people,'' Rheingold said. ``It helped artificially keep housing prices higher than they should have been.''

Delinquencies of more than 90 days on option ARMs increased to 5.7 percent in the fourth quarter from 0.6 percent in the same period of 2006 on loans held by Countrywide Financial Corp., the Calabasas, California-based company said in a regulatory filing last week.

Lenders hold loans in their portfolios when they don't bundle them into securities for sale to investors.

Countrywide had $28.3 billion in option ARMs in portfolio at the end of October, according to Inside Mortgage Finance. The only banks with more were Charlotte, North Carolina-based Wachovia Corp., with $117.8 billion, and Seattle-based Washington Mutual Inc., with $57.9 billion, according to the Bethesda, Maryland-based newsletter.

Option ARMs, which can adjust monthly, are more attractive for banks to keep in portfolios than fixed-rate loans because they adjust at the same time as savings accounts and other deposits used to fund the loans.

Staying Current

Countrywide wrote down the value of $35 million of the loans in the fourth quarter, up from $1 million a year earlier, according to a regulatory filing. The company agreed to be acquired by Charlotte, North Carolina-based Bank of America Corp. after losing as much as 89 percent of its market value.

Wachovia-originated option ARMs were higher quality than other companies' option ARMs, Chief Executive Officer G. Kennedy Thompson said in a Jan. 30 conference call. That's because the bank made sure borrowers could stay current on monthly payments at the reset amount, not just the teaser interest rate, which can be as low as 1 percent, he said.

That was a standard that regulators, including the Fed, recommended in 2006 after the total U.S. foreclosure rate climbed to a five-year high. It has since surged to the loftiest level since at least World War II, according to data compiled by the Washington-based Mortgage Bankers Association.

Tougher lending guidelines have made it more difficult to refinance into new option ARMs.

Regret Making Loans

``The option ARM volume that was done was part of the excess,'' IndyMac Bancorp Inc. CEO Michael Perry said in a telephone interview from his office in Pasadena, California.

IndyMac, the second-largest independent U.S. home lender, made $43 billion of the loans from 2005 through the third quarter of 2007.

``Obviously we've been through what we've all been through, there's many things we regret,'' Perry said. IndyMac no longer makes the loans because mortgage-bond buyers aren't interested, he said.

Washington Mutual also is no longer offering option ARMs to borrowers who put down little or no money or home equity as a deposit, CEO Kerry Killinger said on a conference call last week.

``Washington Mutual continues to offer option ARMs under tightened credit standards,'' Alan Gulick, a spokesman, said today by phone.

The company's unpaid principal balance of option ARMs exceeded their original principal amount by $1.73 billion at the end of 2007, almost double the $888 million of a year earlier, Washington Mutual reported on Jan. 17.

Regional Banks

Regional banks are feeling the effects of option ARM delinquencies, said Andrew Laperriere, managing director of New York-based research firm International Strategy & Investment Group.

FirstFed Financial Corp., the Santa Monica, California-based savings and loan whose net income slumped 75 percent last quarter, blamed option ARMs hitting their negative-amortization caps for higher delinquencies. More than 1,800 of its borrowers hit the limits, and 2,400 more may this year, the company said Jan. 25.

Laperriere estimates that 85 percent of option ARM borrowers owe more than their original loan balance.

``The problem is, you can refinance an option ARM to a 30- year conventional loan at a 5.5 percent interest rate, and you're still looking at your payment going up 150 percent,'' Laperriere said. ``That's pretty ugly.''

About $460 billion of adjustable-rate mortgages are scheduled to reset this year, with the next spike in resets coming in 2011, when $420 billion in mortgages will adjust to new interest rates for the first time, according to New York-based analysts at Citigroup Inc.

That's the year that Joe Ripplinger's payment will jump, provided he doesn't reach his negative amortization cap before then.

``It's the worst thing we could have done,'' he said.

Bloomberg.com: Exclusive
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