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December 7, 2007
Mortgage rates are back above 6% this morning (despite Freddie’s “Fell Below 6%” headline in today’s papers, the result of an early-week survey), the definitive 10-year T-note is now 4.12%, a long way from the 3.85% bottom in the last two weeks.
A 94,000-job gain in November payrolls reported this morning didn’t help -- the bond market was hoping ghoulishly for an off-the table figure -- but the real damage was done yesterday by the sub-prime workout plan. It won’t work, of course (see below), but as I said last week, signs that government is waking to the hazard in the Crunch will mark the bottom in long-term interest rates.
For bond and mortgage yields to go lower, even return to the Thanksgiving bottom, we will need news of deepening Crunch: the failure of a bank or two one morning, or by credit market counterparties (bond or mortgage insurers); or word that the real economy is slipping to negative, or a Dow dive below 13,000.
In the Eurozone, outright bailouts are already under way: huge HSBC took back $45 billion in bad paper it had sold, worth perhaps half that, a hit bad enough to impair its capital. Next day, business as usual. Most of the world is not as prissy as we about the need to bail out major institutions, easily overlooking a mere shortage of capital.
The Fed will cut its rate next week. If .25%, nothing to help mortgages (already built in); .50% more likely to hurt than to help. All bond traders know to sell before the Fed ends an easing cycle; for the Fed to go below 4.00% (4.50% at this minute), the Crunch will have to deepen. I think it will, but the bond market wants to see the fact.
The sub-prime workout will be a blessing to any family whose home is saved. However, as an economy-wide reality, benefits from the workout will be undetectable. This episode will defy workout efforts for several reasons.
1. The primary cause of foreclosure is zero or negative equity, today the widespread aftermath of a plague of idiotic and predatory 100% lending. No hope for these homes.
2. The first step in workouts is to add delinquent payments to balances and recast future payments (“capitalized interest”). See #1: no equity, no room to add.
3. Another common workout: convert to a period of interest-only. A ton of these troubled loans already are interest-only.
4. Another traditional approach: reduce the interest rate. Fabulously successful in the 1980s was the FHA “streamline refi” (available today, but only for FHA loans). Families under water versus value or in job trouble were stuck with 14% loans and walking away; a streamline allowed refi to then-current 8% with no proof of income and no appraisal. Won’t work today: the inventory of loans made ’01-’06 has average rates too close to today’s.
The Amateur Hour team at the Fed and Treasury have missed two remedies. The obvious one: restore an adequate supply of new credit (re-guarantee Fannie and Freddie, expand limits; un-block bank financial statements). Rate cuts, discount-window blabbing, and announcements that the Crunch is loosening... get with it, guys.
The sub-prime fix that would work is technical, but easy: cut the margins in the loans, existing and future. The life-of-contract “margin” in an ARM is the spread paid over index value; in “A”-quality primary residence loans, below 3%. What makes a sub-prime a sub-prime is a margin in the 5%-6% range. The one, quick stroke of broadsword available now: limit primary residence margins to 3%. No negotiations or re-qualifying, no work for servicers at all -- simply extinguish the predatory resets.
A shriek from the Right and The Street; “You can’t re-write existing contracts! You’ll damage the market!!”
The hell we can’t. We do not respect the contracts of loan sharks -- by definition, terms that a borrower cannot meet. If your idea of a market for mortgage-backed securities is the back-alley knee-capping of three million households, we have every right to alter your “terms.”
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