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July 7, 1989
This morning's market indicates that the Fed has eased another quarter of a percent in Fed Funds, down to 9.25%. Today's June Employment statistics were moderate, as expected: NonFarm Payroll up 180,000, Unemployment up .1% to 5.3%, but May figures were revised to a stronger pattern.
Other data this week confirmed surprising weakness in the economy. The Purchasing Manager's Index fell again, down to 48.8%, and Factory orders fell 2.5%. Though overall Construction rose 1.3% in May, Single Family building declined 1.5%, and Multifamily dropped 6.7%.
Though the bond market has continued to rally, mortgage rates have had a hard time falling below 10% in the last few weeks. Some of this widening spread is natural as mortgage rates get within a percent or so of decade lows. However, this time around, the collapse of the S&L industry is a big part of the cause.
At least a thousand thrifts which hope to survive have capital only in the sense of accounting gimmicks. One shell game has been "good will," showing as capital the excess of purchase price of another institution over its value. The practice helped FSLIC unload some sick S&Ls, and helped some high flyers grow fast. However, it's a lot like offering $125,000 for a house worth $100,000 while applying for a $100,000 loan and claiming $25,000 in equity.
Equity in a financial institution is as desirable as in any other borrower. If the borrower has no money at risk, it is a whole lot easier to take risks.
The bailout bill in Congress will require about 3% honest folding green capital as a percent of deposits at all S&Ls. This requirement, though wise, is temporarily propping up mortgage rates. Undercapitalized S&Ls can magnify capital levels by shrinking deposits and selling assets. Three dollars of capital is only .3% on $1,000 in deposits; but if we shrink the S&L to $100 in deposits, we have 3% capital. Big declines in S&L deposits this year are not so much a panic run as prudent downsizing.
If deposits are to contract, corresponding assets must be sold. One or another gutshot S&L has announced each week the "planned sale" of several billion dollars in mortgage assets.
This selling pressure will abate, and there is more room for mortgage rates to fall.
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