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March 2, 2007
Mortgages are nearing 6.00% for the first time since last Thanksgiving, pulled down by a general flight to high-quality assets (yes, US-agency guaranteed “A” mortgage paper is still high-quality). The 10-year T-note at 4.50% has again priced-in a Fed easing by summer (wrong several times in ‘06, might at last have it right).
For cause of the global stock-market ker-plunk, we have all sorts of offerings. The most entertaining is the “Tales From the Crypt” version, blaming Mr. Greenspan’s mention of end-of-cycle recession possibilities. Any minute we’ll get Vincent Price on sub-prime, and Edgar Allen Poe on inflation.
Stick with the basics: last year marked one of the longest periods of record-low volatility and equally low premia for risk ever measured. Such episodes always end badly. Catalysts are almost irrelevant: a retired Chairman, a mortgage-induced meltdown in the black-box bond market, an end approaching for free-lunch yen borrowing, weaker economic data... whatever. Risk will re-price.
The economic data: January orders for durable goods were awful, down 7.8%, poor in all sectors; 4th quarter GDP revised from pink-of-heath 3.5% to a grayish 2.2%, business investment fading; the purchasing managers’ index “improved” to nose-above-water; and new claims for unemployment insurance are suspiciously high. Sales of existing homes a small positive, sales of new ones... don’t ask.
The main event, of course, is the housing-mortgage-Wall-Street waltz. Watch each dancer separately, then look for patterns; otherwise it’s just one big furball.
OFHEO released its 4th quarter home-price index yesterday, the only reliable indicator of changes in actual prices paid. The dominant notations: zeros and ones. Out of 282 metropolitan statistical areas, only 25 had price declines, but national appreciation in the 4th quarter was only 1.1%, following a 1.0% 3rd quarter. The deceleration in those two quarters from the prior five years is extraordinary: of the 20 highest-appreciating MSAs in the last year, only one still has a double-digit gain.
Home prices are not “falling fast,” as in the media shriek, but OFHEO’s flat-price stats are backward-looking and mask deterioration underway. There is a large overhang of un-sold homes whose discounted prices will not show up until sold, and it takes years for flat prices to fully expose unfortunate and ill-advised homeowners.
The media and even regulators are mesmerized by their discovery that most sub-prime lending has been predatory. However, sub prime per se is not the problem: the trouble is little or no down payment, or total equity extraction by refinance, both coupled with foolish underwriting. Little or no equity and a dead-stop to prices... that’s big trouble for any loan type.
How many low/no equity households are out there? Nobody really knows, not even the Fed. If prices retreat even a modest 5%, how many more low/no households? Then, even if not in job/health/marital distress, how many households will tough out high payments with no equity to defend?
Enter regulatory failure. Freddie’s comical announcement that it will stop buying sub-primes next September [!!!], is the first response from anybody to the Fed’s toughen-up-your-underwriting guidance last September. The Fed issued another toughen-up guidance today (subject to two months’ public-comment delay). If you want to have some fun, call their press office (202-452-2955) and ask if the Fed has noticed that no one in the marketplace has paid any attention to them.
The Fed has blown its responsibility to supervise safety and soundness, first blind and now helpless to the migration of mortgage finance to securities dealers. The immediate risk, as I said last week, is at those Street dealers and in a couple of trillion dollars-worth of their recent creations. Old hands say that even the dealers don’t know how much trouble they’re in. What they do know, they ain’t sayin’.
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