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July 27, 2007
In the financial panic underway now, frightened money is pouring into Treasurys, but for the first time in modern experience the overflow is only a modest benefit to mortgages. The 10-year Treasury note is all the way to 4.78%, down a half-percent in three weeks, but mortgages are stuck near 6.625%, just a hair off the June high.
This disconnect is the mark of credit suspicion extending all the way into Fannie/Freddie “A” paper -- very much misplaced concern, says here. Mortgage defaults will spread into Alt-A, and some parts of “A” adjustable-rate pools, but the old-fashioned, main-line Agency underwriting will hold up. The Treasury-mortgage spread should begin close, to the benefit of mortgage applicants.
There are two separate credit events underway, and a gazillion money bloggers are trying to combine the two into a financial cascade. Don’t buy (yet).
Event one is the still-orderly downside to the biggest-ever boom in home prices. Event number two is the disorderly adjustment on Wall Street from absurdly underpriced risk, the extent of repricing and consequences unknown. The ONLY connection between the two: a minor portion of the Wall Street underpricing was bad mortgage ideas, now defaulting in the housing recession. The larger part: Wall Street bloated by a sub-prime mortgage equivalent in corporate finance.
Housing in the Bubble Zones is still sliding, inventory accumulating, foreclosures rising, all likely to continue for years. Those ignorant of housing propose resolution by sellers cutting prices, but it doesn’t work that way: overextended prices stay flat until purchasing power accumulates to support them. The farther the boom pushed prices beyond purchasing power, the longer it takes. This time, years and years.
Financial market commentators now speak casually of home prices falling 7% or 10% or another percentage du jour. Prices will fall that much in some micro-markets, but most of the country did not join the Bubble party, and will experience nothing of “falling prices.” The stock market can fall single-piece in a heap (99% of the S&P500 stocks fell in Thursday’s wreck); homes are a neighborhood-by-neighborhood affair.
Have generally flat prices of homes diminished consumer purchasing power? Sure. Made the economy a tad fragile, could get worse? Sure, sure -- but housing is going to unfold over time, and there is no good way to know the side effects in advance.
This Wall Street credit event is an entirely different matter. A “credit crunch” is a lender strike, and a bad one is a common initiator of recession: not just raising rates for risky deals, but choking off credit altogether.
In this cycle, bad mortgages were merely the first of the overpriced parade to be exposed, but that was a matter of luck, not linkage. The real economic link here is not housing-to-mortgages-to-stocks, it is the one from the global excess pool of savings to Wall Street. The buyers over-paying for IOUs have been led by Asian exporters and Petro pushers desperate to earn a return on their winnings. Along the way they have propped prices of all other traded assets, and invented ones called “derivatives.”
To cause a recession, a credit crunch has to be big and durable enough to harm the real economy, not just Wall Street. So far in this one, The Street is stuck with piles of IOUs that it promised to buy, and did, but now cannot re-sell. Clogged drain. In the best line by far to describe current conditions, Bill Gross wrote a country-boy metaphor: “This is the constipated owl -- absolutely nothing is moving.”
If the Asian/Petro investors go to cash, earning 5% in dollars or 4% in euros, and stay there, then the owl’s condition will persist and the disaster-bloggers will have better copy. Alternately, the cash-drowning vendors to us will begin to nibble at the much higher yields and lower prices suddenly available in the markets, loosen-up the owl, and we can get back to watching finance types try to understand housing.
And watch the serious show: the Fed leaning against $75 oil while the economy is gradually slowing.
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