February 29, 2008

     Mortgage rates have begun a decline from the irrational levels of the last month, now approaching 6.00% and says here likely to cross back into the fives.
     Part of the decline is due to deteriorating economic news. The toughest was a surge in new claims for unemployment insurance, up to 373,000, consistent with recession and suggesting that next week’s payroll report will show February contraction. Orders for durable goods tanked 5.3% in January, as have February measures of consumer confidence. Inflation is worrisome, but a soon-to-blow commodity bubble will fix that.

     A two-part story today, housing as scapegoat for the failures of others. The real causes of this credit crunch -- still called “subprime” -- and the recession it has spawned are the grotesque failure of structured-finance products on the Street, and failure of oversight by their regulators.
     The strange story of mortgage-rate spike and reversal began with the January fable that mortgage-backed securities (MBS) issued by Fannie, Freddie, and Ginnie (the “GSEs”) had become too toxic for investors to hold. That notion made no sense here: these GSE/MBS are as good as Treasurys, no matter what the ultimate default rate of mortgages within (Ginnies are guaranteed by the Treasury, F&F clearly “too big to fail”). The GSE/MBS market is $4.5 trillion, the deepest and most liquid market for anything on the planet except US Treasurys.
     Yet, traders said throughout February: “Too many MBS sellers.” The excess on the market was certainly not new loan production. Now we know who those sellers were: big banks and Street dealers, capital impaired, dumping the only liquid assets they have to make room for trash flooding back onto their balance sheets. The back-wash: the remains of deals they sold but agreed to support if “something went wrong.”
     The February went-wrong: almost $1 trillion in “auction-rate” securities -- actually good-quality muni-bonds, but held in short-term rollover structures (note: nothing whatever to do with housing or “subprime”). When rollover failed in renewed crunch, an avalanche of illiquid paper hit banks, triggering MBS sales and higher mortgage rates.

     The financial press is having a wonderful time ginning-up a housing depression, this week shrieking about new home-price data: “Decline in Home Prices Accelerates” (WSJ), emphasizing the Case-Shiller index, down 8.9% in ’07.
     Case-Shiller is designed to magnify home-price declines. Mr. Shiller correctly called the stock market bubble (his book “Irrational Exuberance” appeared on the day of ’00 collapse), and has spent the last several years mis-applying financial-market principles to real estate, gleefully predicting a 30-40% national crash in home prices.
     The design flaw: it captures only sales of homes, obviously heavy with distressed transactions. For the authentic story and great methodology, visit www.OFHEO.gov and its All-Transactions House Price Index, which includes repeat appraisals in refinances, by definition free of distress. By that measure, national home prices in the 4th quarter rose by .8%. Prices fell in only 11 states, and in only five of those were declines in excess of one percent. See page 21 of the report for its critique of Case-Shiller.
     At the micro level, some spots are in horrible trouble: of OFHEO’s 291 Metropolitan Statistical Areas, 15 had price declines last year in the 10%-19% range (all CA and FL). And the national market is decelerating: of 39 states with positive appreciation in the 4th quarter, 32 had gains of less than 1%.
     The key to this unpleasant situation: housing is sinking because of credit starvation, not the other way around, housing wrecking credit markets. No matter what it takes, the supply of credit must be restored to housing and the rest of the economy.
     The public policy response is still frozen, Democrats trying to help families who cannot afford their homes to stay in them, Mr. Paulson refusing assistance to the financial system: “I’m not interested in bailing out investors, lenders, and speculators.”

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