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June 29, 2007
The 10-year T-note fell this week all the way to 5.05% from its 5.26% top two weeks ago. Mortgages have settled today near 6.75%.
The rate decline has had several contributors. In approximate order of importance: fear of default on widening classes of ill-advised debt has pushed money to high-quality paper; a “retracement” from the crest of a big move is normal; and gradually improving inflation data are tilting the Fed from a tight stance toward balanced.
Last, regarding an accelerating US economy: wait-a-minute-fellas. Home sales are still falling, and un-sold inventories are up to an 8.9 months’ supply, a 15-year record. Weakness in both consumer confidence and orders for durable goods put the second half of 2007 in question for anything much beyond 2% GDP growth.
Everyone is trying to form a housing forecast... how long, how deep, how bad the collateral damage, except for those who participated in the Great Derivatized Mortgage Train Robbery, who are doing their level best to keep everyone confused.
The forecasters have run out of metaphors. I’m waiting for these headlines: “Canary Found Dead In Iceberg,” followed by “Tip of Coal Mine Feared.” Meanwhile, the cover-uppers are selling a variety of urban legends and Tales of The West.
Legend Number One: loosened standards in 2006 and late 2005 are responsible for the sub-prime damage, which will be limited to those loans. Nonsense. We (and all other retailers) were offered the first suicide loans back in 2000, which then and now fall into two generic groups: 100% LTV in any form, with or without borrower documentation, and ARMs with last-cigarette adjustment structure. The roll-out of these loans coincided exactly with The Street’s discovery of “credit derivatives.”
The ultimate foreclosure damage was masked by a decline in interest rates to a fifty-year low, and a roaring, self-reinforcing run in home prices.
Number Two: Fraud by Main Street lenders has been the main problem. It is a problem; it has always been a problem, and its depth is always discovered when home prices go flat. In today’s parade of mortgage horrors, fraud is not even a secondary cause. The authentic ones (back to those two generic loan types): if you have no equity at purchase, and prices go flat, and anything goes wrong in your household, you’re cooked. Prices went flat in 2005; that’s the problem in ’05-‘06 loans, not easier credit.
Then the ARM-structure effects. In 2006 the Fed took short-term rates from the 1% bottom in ’02-’04 to 5.25%. ARM indices follow the Fed: in ’02-’04 a sub-prime borrower adjusting to 5% over Libor at the end of year two or three (the despicable “2/28s and 3/27s”) only went to 6% or 7% pay rate. Now... to 10% or 11%, a disaster having nothing to do with “eased standards” in ’05 and ’06 originations.
Tales of The West... Housing will bottom when sellers finally reduce their prices enough. Better hope not: that would extinguish the equity in another 15% of households beyond the 15% that have little or none now.
Another: workouts -- negotiated loan modifications -- will control the foreclosures. Foreclosure hotlines and counseling are doing excellent work, saving many families, but there is terribly little negotiating room. One classic workout: add delinquent payments to the mortgage. Works if there is equity, but without any... toast. Another is rate-reduction, which worked beautifully in the ‘80s (the FHA and VA “streamline refi”) to re-write 14-15% loans down to 8-9%. However, rate-reduction requires a lower market-rate world; today, rates are far higher than when the suicides were assisted. It may be possible to re-write sky-high ARM adjustments, but only at the cost of deepening panic in the credit markets, cash flow collapsing. Take your poison, indolent regulators.
The next canary to hit the iceberg: S&P and Moody’s are soon to be exposed in the worst systemic rating error ever. They are going to have to re-rate hundreds of billions of new-age mortgage paper, forcing institutions to acknowledge losses beyond estimation, and in so doing admit their own fiduciary failure: fee for blindness.
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