Mortgage rates have been low for many years, but if things continue at their current pace, that isn’t going to last much longer. The biggest factor controlling the rates charged for standard 30-year mortgages is the price of bonds (called mortgage-backed securities) sold by Fannie Mae and Freddie Mac. Over the past few years, these bonds have been selling with an interest rate just a little higher than U.S. treasuries. Now, with all the problems being talked about surrounding Fannie and Freddie, investors are becoming more cautious. In case you need help connecting the dots, that means investors are requiring a higher spread on these notes. The more Fannie and Freddie have to pay to secure funds, the more they are going to have to charge to their borrowers; it’s that simple. The bigger question to think about is how these higher mortgage rates will affect an already suffering real estate market.

Probably the biggest single factor behind the housing bubble was the abundant access to cheap credit. More people than ever were buying homes because more people than ever could qualify for loans. This was in part because of law borrower credit standards required by lenders, but it was also in part because of the low interest rates offered. Homebuyers tend to focus more on the monthly payment than the actual purchase price of a home. If they know they can afford $2,000 a month, then they are willing to buy a home for up to that payment, whether it costs $250,000 or $400,000. With all these new buyers entering the market, and people now able to afford more home than ever before, this scenario created the perfect atmosphere for a run-up in housing prices. Now let’s look at present circumstances.

On a historical scale interest rates are still low, but compared to the interest rates during the height of the bubble, they are substantially higher. While interest rates are low compared to historical averages, housing prices are high compared to historical averages. With mortgage rates rising, along with the credit standards of lenders, we are getting the opposite effect of what we had during the bubble run-up. This means that we are decreasing the number of people who can buy homes in addition to decreasing the amount of home for which people can qualify. Obviously this is going to negatively affect the housing market. While we certainly have seen a sharp contraction in the housing market compared to what existed during the bubble’s peak, if mortgage rates continue to rise, you can bet that the contraction will continue and become even sharper.

Keep an eye on the investor confidence in Fannie Mae and Freddie Mac. If somehow the companies can regain this confidence, then mortgage rates could stabilize, but at this point that doesn’t appear likely to happen anytime soon.

Labels: Fannie Mae, Fed, Freddie Mac, housing bubble, mortgages, real estate

The Fed approved some new measures Monday meant to crack down on what they deem to be deceptive lending practices. Because most of these problems have already worked themselves out, thanks to the whole credit crisis thing going on, these measures likely will have little impact. But just for fun, let’s take a look at what the changes are.

The following summary was collected from the San Francisco Chronicle:

Rules for all mortgages

- Prohibit creditors and mortgage brokers from coercing appraisers into misstating a home's value.

- Require additional information about rates, monthly payments and other loan features in all advertising.

- Ban seven deceptive or misleading advertising practices, including calling a rate or payment "fixed" when it can change.

New lending rules

- Force lenders to consider a borrower's ability to repay loans from income and assets other than the home's value.

- Require lenders to document a borrower's income and assets.

- Ban penalties for borrowers who pay off loans early if the payment can change in the first four years. In certain cases, a prepayment penalty period can't exceed two years.

- Mandate that creditors ensure certain borrowers set aside money to pay for property taxes and insurance by establishing escrow accounts.

The “new” rules for all mortgages are welcome additions, I guess, and really should be no brainers. I’m pretty sure coercing appraisers into misstating home value was already a no-no, but now it is “official,” for whatever that’s worth.

The new subprime lending rules are, for the most part, already being followed. At this point in time a borrower is going to be hard-pressed to get a loan if they can’t document their income (unless they are putting down a large down payment). Also, on almost all loans now--and in recent memory--lenders have required escrow accounts to pay for taxes and insurance. Since this was the norm even during the subprime heyday, I’m not sure exactly what they were trying to accomplish, but I guess we can now use that “official” word again. The biggest change that I can see is with the pre-payment penalties. In the past, having a two year pre-payment penalty was pretty much the norm, and borrowers who wanted to get that waived had to buy it off. From the lender's perspective it made complete sense: They wanted to ensure that they were able to make at least X dollars on the loan even if the borrower sold the house the next day. This is one that I think could backfire for borrowers. Now that lenders are not going to be able to add a pre-payment penalty, they are going to make the loan more expensive because they have to ensure that they are able to make their profit no matter what the borrowing time frame. So we can expect that buy-down pricing will now be included in every loan--whether the borrower wants it or not. The borrower who knows that they are going to be in the property for at least two years will now have to pay a little more on their loan. I think a better solution might have been to make the pre-payment penalty opt in rather than opt out--that way people who do want it can still have it.

All in all, I think these new regulations were more for show than for function. The government needed to appear like they were trying to do something about the problem, so they put together a list of things that look good on paper, but in practice are pretty much useless.

Labels: Fed, mortgages, real estate

Can the Fed rate cut history show us the future for Fed rate cuts? I always knew that for the most part we have been able to fairly closely determine whether or not the Fed was going to cut the funds rate--and if so even by how much--but this morning I learned something new that I wanted to share. Before, I always looked at Fed fund futures to weigh the chances of a rate cut or increase, and while these future contracts tend to give us a pretty solid estimate, they have historically overestimated the Fed rate cuts, according to Ed Nosal, economic advisor at the Federal Reserve Bank of Cleveland. So how else can you accurately determine whether a rate cut is coming or not?

Elliot Wave International is one of the largest forecasting firms in the world, and they think they can predict to a T when a Fed funds interest rate change is coming and how much it will be for. They don’t look at the Fed fund futures, though; they look at the 3-month T-Bill yield. They put together a chart that you can see below, which shows just how accurate this method is:



"And forecasting fed rate cuts isn’t all it's cracked up to be, or at least it doesn’t appear to warrant the countless hours of discussion devoted to it on financial television. As we’ve discussed numerous times in our newsletters, the Fed follows the market, not leads it. This quasi-government entity simply validates what the freely traded Treasury market has already done. The above picture should be familiar to long-time subscribers and illustrates our point about the juxtaposition between the Fed and the freely traded T-bill market. With the current gap between the U.S. 90-day T-bill rate and Fed Funds at a wide 112 basis points, the Fed’s rate cutting is not over," Steve Hochberg, Elliot Wave International's chief analyst, wrote Jan. 22 in Elliot Wave’s Short Term Update.

So if you are trying to figure out what the Fed is going to do about interest rates at their next meeting, now you have a new crystal ball to look at. As for what is going to happen at the next Fed meeting, almost everyone believes the Fed will stand pat on the fed funds interest rates, including Donald Kohn, vice chairman of the Fed.

Labels: economy, Fed

Identifying a recession is a tricky thing, and that was never more apparent than in the flip-flopping of many economists’ opinions on the state of the economy and its odds for a recession. It wasn’t too long ago that 71 percent of economists believed we were already in a recession, and even more thought a recession inevitable. Wachovia, which last month put the odds of recession at 90 percent, just downgraded those odds to 45 percent, according to The Wall Street Journal. Is the economy really turning around, and can we begin to be a little optimistic about the future?

Recent data released by the government has been a little better than expected, but I think we are missing some things. Perhaps we are clinging to any last ray of hope we can find, but the bottom line is we should look at the facts for what they are, not coat them in sugar. One example is that yesterday everyone was elated that the CPI came in at only a 0.2 percent increase, compared to the expected 0.3 percent. This surely is good news--I don’t want to discount that--yet at the same time we can’t take this to mean that our inflation fears are over and that everything is peachy. First off, I have my concerns that the numbers being reported by the government aren’t all that accurate to begin with. In addition, while inflation might be taking a little break, so to speak, I don’t think it is gone.

Another piece of irrational exuberance in my book was how the market treated the recent earnings reports from Freddie Mac and Fannie Mae. Fannie Mae reported a loss of more than $2 billion, much more than was anticipated, yet their stock skyrocketed that same day. Something just doesn’t seem right about that. Then this week, Freddie Mac actually beat estimates and reported a loss of only around $150 million. That seems great compared to the $2 billion loss over at Fannie, but in order to cut their losses to only $150 million, Freddie Mac had to alter their accounting methods. I’m no accounting expert, but any time I hear of companies altering their accounting practices, and voila, their books suddenly look better, I get suspicious (if anyone has more knowledge about this, I’d love to hear your take). As we saw in the foreclosure numbers reported this week, the housing problems are far from gone. More and more people are losing their homes, and to me that doesn’t spell good news for Fannie and Freddie, or the housing market in general.

We also saw reports this week that more companies are laying workers off--typically not a positive sign at all--yet for the most part the markets shrugged off this news in favor of celebrating the fact that inflation was only at 0.2 percent last month. While it certainly is good news to see the economy rebounding somewhat, and for the economic news to come back better than we expect, I urge investors not to get their hopes up too much at this point. It is possible that the interest rate cuts and the economic stimulus package will come together to bring our economy out of the rut it’s been in, but I certainly wouldn’t put those chances as high as 55 percent. I still think a recession is coming, and whether it is officially here now, or whether we are able to delay it, it will surely come. Our economy has too many serious problems to fix with a few Band-Aids.

If Bernanke discovered the magic recession avoidance elixir, that is just fabulous, and we all should be ecstatic.

At the same time it has always been my belief that you plan for the worst, so that’s what I’m doing. Jump on the U.S. economy is great wagon if you will, but be careful, because I’m pretty sure the axel is loose.

Labels: economy, Fed, finance

The Fed is meeting again today and tomorrow. To mark this diminishingly historic occasion, I have composed the following ditty. Ahem...


Thank you. Thank you.

As the Fed disappears behind the curtain yet again, ‘O we of little faith’ are bracing for yet another quarter percent drop in interest rates. Soon it will be official: You will likely see more appreciation on kitsch from the Franklin Mint than anything that comes out of the U.S. Mint. My friends all laughed when I plunked down 100 smackers for my Mystical Dreamcatcher Pocketwatch, but who’s laughing now?!

For those of you who didn’t have foresight enough to invest in chilling likenesses of dead royalty and zirconium encrusted daggers, allow me to predict what the Fed is planning to do. Just let me look into my Dragon of Lore Crystal Ball (a steal at 5 payments of only $39.99!)...

As we can see, it’s all business as usual at the Federal Reserve. But before I go off to polish my collection of Elvis Head Silver Dollars, I leave the Fed with three bits of advice:

1. These are tough, confusing times, and I do in fact sympathize with anyone tasked with sorting this out, but your methods have proven to be the financial equivalent of bloodletting for the ailing economy. Try something new for once, PLEEEEEEEASE!
2. We know the banks own you (literally), but at least pretend that you have the interest of the American people in mind. You know, we love a good circus act. And if you piss us off, then...
3. Don’t stiff the pizza boy: He knows where you live.

Labels: Bernanke, Fed, finance, inflation, recession, stagflation

The Bush administration is calling for a major overhaul of how we monitor the financial industry in what would be the largest financial regulatory makeover since the Great Depression. It isn’t as much oversight as many Democrats are demanding, but it is fairly substantial.

I am generally against added government regulation, so this doesn’t sit well with me. The government has a way of making things more complicated and costly than they need to be, and it is taxpayers who bear the burden. Increased regulations in the financial and mortgage industries will only make lending tougher. It seems that people want the government to protect them from themselves and from lenders who might take advantage of them. If the government gets involved, some people may be protected, but fewer people will receive mortgages. In an already struggling market in which it is increasingly difficult to find funding, the last thing we need to do is to make it even more difficult.

I expect that the regulatory agency will, at a minimum, call for increased documentation and transparency on the part of the lenders. I’m all for transparency, but the documentation is already overdone. When I signed the docs for the last house I bought, my hand started to cramp halfway through signing all the paperwork. If increased paperwork is all they do, and they do not become too restrictive, then the legislation shouldn’t have much negative impact, though it will mean more work for the loan officers, processors, lenders and escrow agents. If they start modifying loan qualifications and guidelines, or imposing penalties on lenders, it might scare many lenders out of even remotely related programs. If lenders become even more hesitant and restrictive, this only spells more bad news for the housing market.

Labels: Fed, finance, housing bubble, mortgages, real estate

Yesterday, the Fed did what everyone expected by cutting interest rates. The 0.75 point interest rate cut was lower than the full 1 point rate cut that futures traders were expecting, but within the range most people expected. It is doubtful that this interest rate cut will revive the economy for more than a brief showing on the stock market, and most people expect further interest rate cuts in the future. President Bush also mentioned yesterday that he is willing to take further measures to revive the economy, but first he wants to see how his economic stimulus package pans out.

Rather than discussing future cuts and policies, let’s talk about the present: The U.S. dollar is now the second lowest yielding major currency. The lowest yielding currency is the Japanese yen, which has pretty much maintained that title since Japan’s financial meltdown in the '90s (see previous post: Could The U.S. Be Headed For A Recession Similar To Japan's In The '90s?), which was eerily similar to the one the U.S. is experiencing. The U.S. dollar yields 2.25 percent, while Japanese yen yields 0.5 percent. The dollar still has some room to fall before it gets that low, but it is well on its way.

Why is the yield of a currency important?

Investors want to see return on their money, so if they aren’t getting the returns they seek at home, they will start to look elsewhere. For a good example of this, we can look to Japan. The Japanese don’t want to keep their savings in yen because they earn almost nothing on it, and with inflation is higher than interest rates, they are actually losing money. Because of this, people take their savings elsewhere. As more people sell off their yen, the currency goes lower.

There are also the carry traders who borrow money at low interest rates and invest that money in higher yielding currencies hoping to profit from the yield difference. Again, these traders are selling the low-yielding currency (lowering its value further) and buying higher yielding currencies (raising their value). Carry trading has become popular of late, and its power to move currencies should not be overlooked.

For the reasons mentioned above and others, as currencies decrease their yield their value goes down, and as the yields get raised the currency value goes up. The fact that the U.S. keeps lowering the dollar yield is further reason to believe that the dollar will continue its slide.

Labels: dollar, economy, Fed

For those who haven’t already seen the headlines in the local paper, Bear Stearns agreed this weekend to be acquired by JP Morgan for $236 million or about $2 a share, a sharp contrast to its 52 week high of $159. In addition, on Sunday the mortgage-bond fund Carlyle Capital decided to close up shop. Many people believe that this is only the beginning of the financial melt down. How will the Fed respond to these recent events at their meeting today?

The Fed will likely lower the key interest rates yet again, anywhere between .5 to a full point. Most traders will welcome as large a rate drop as Bernanke will give after the hammering the markets took this past week, but people who have their savings held in dollars might have other thoughts.

I know that I’ve been pounding this point home a lot lately, but the Fed is destroying the value of the dollar. I can’t imagine that it will be much longer before any foreign countries buying up U.S. treasuries start to think twice. What will happen then? The U.S. is funding its enormous debt by issuing more debt, and if that option gets reduced or eliminated there will be serious consequences. The options come down to printing more money (and further deflating the dollar) or default, and neither scenario would end well.

I’ve said it over and over again, but if you aren’t already diversifying out of the dollar, do it now. It is ok to keep some savings in dollars, but people really need to start looking at a basket of currencies. EverBank offers a product called a foreign currency CD which will pay interest on your money and also allow you to easily diversify into other currencies. They even offer various baskets of currencies to aid with diversification. EverBank also offers silver and gold CD’s, which is a simple way to diversify into the precious metals market.

Labels: Bernanke, economy, Fed