R C's Blog

Why Bailout May Be The Only Saving Grace

ECONOMIC NOTES Monday February 11, 2008

Mortgages struggled to stay as low as 5.75% (more below on the stubborn refusal of mortgages to follow the Fed down).

The biggest news of last week: the off-the-table January ISM survey (the ineptly re-named purchasing managers’ association), one of the very best real-time indicators, the 54-to-41 plunge the worst monthly result ever. A general intake of breath followed, not yet released. January retail sales were the worst in five years; credit cards declined in use and increased in distress; and Wal-Mart reported, sadly, that shoppers are using holiday gift cards to buy necessities -- diapers, pasta sauce, and detergent.

The only questions remaining: how deep and how long the recession?

This one is different in pattern from others (save perhaps ’91-’92 affair, a micro-mini crunch). By summer ’07 consumers were stressed by energy and housing, but the economy was still rolling along when the August Crunch began to tip it over. Standard recessions are consumer-first, then financial and credit trouble; this is vice-versa. Caught by atypical surprise, policy makers have floundered and flinched.

The problem: the August revelation of some $4 trillion in troubled assets. They had accumulated for years under the pretense of performance, but deteriorated steadily since ‘05. Each banker knew his own trouble, and in flash chain reaction each stopped dealing with his peers for fear that they were in as bad shape as he. Crunch.

That crunch was symptom, not cause. Since August we have been in an episode of “House”: while the Fed medicated the interbank symptom, the actual disease worsened, the crunch broadened, the economy deteriorated, and new symptoms forced the Fed into an undignified rate cut. Four times the Fed has cycled this way, patient sinking.

Enter Congress. Treasury Secretary Paulson set up Mr. Bernanke as messenger boy to plead for spending stimulus. New medication, wrong disease. There’s a lot we could do with $160 billion (one-fifth would have re-capitalized the bond and mortgage insurers, preventing perhaps hundreds of billions in write-downs ahead). This package will do nothing for the underlying problem, and was unnecessary: the Federal deficit has suddenly exploded from $150 billion to $400 billion, stimulus aplenty.

Bad ideas are pouring from pols and regulators, trying to get foreclosure toothpaste back into the tube instead of working on the real problem ($4 trillion...). There is no solution to foreclosures; most of these households were bad credits to begin with.

Brand new from energetic but dim Sheila Bair at FDIC: forgive loan balances (Whose? Ours? Please?). Increase the speed of workouts (From zero and pretending, to what?). Senator Dodd: intercept foreclosures by Treasury purchase of bad loans (Why just those?). Mrs. Clinton: freeze rates (ARMs began in 1980, rates fell for 25 years, and the first time rates go up, cancel the contracts?). Freeze foreclosures for 90 days (What to do on day 91?). James Lockhart, regulator of Fannie and Freddie, working overtime to disrupt their mission (Mr. Power-Freak, we created them for this moment!).

Fellas... look: What are you going to do with the $4 trillion in bad paper? The “plan” seems to be to leave most of it in the banking system, financed by central bank credit. Hapless investors hold an unknown fraction, paralyzed as new buyers of securitized credit. The Fed-reduced cost of money will widen banks’ investment spreads, increase earnings and over time generate new capital. Over time. Meanwhile -- years -- the financial system cannot provide new credit because of the rotting mess in its belly.

Why are mortgage rates stuck up high, at just the moment that housing is desperate for cheap, well-underwritten credit? Banks cannot buy new Fannies, Freddies, and Ginnies because they are short of capital. Rather worse, they face new losses, balance sheets crowded with bad assets. So, they are sellers of the only good stuff they have. Sellers of our stuff. Sellers.

We would very much like to be proven wrong, but the word is “bailout”: extract the rot from the system and put it into a nouveau RTC. Then markets can function.

Economic Notes is published weekly by the Economics Department of Universal Lending Corporation as a service to Colorado Real Estate professionals. © 2008, all rights reserved.

Another excellent question - glad I asked.

5 steps to the answer

1. Call someone you can trust in the mortgage business - c'mon, there are still some honorable people in the business, in spite of what the press would have you believe.
2. Get a "Good Faith Estimate".  That's a specific document that's used by all legit mortgage companies and will provide you with the interest rate, the payment on the proposed loan at that rate, and the closing costs.
3. Add up the costs of the transaction - in other words, disregard the money involved in setting up escrow accounts for taxes and insurance . . . you have that expense whether or not you refinance, so they don't factor in this equation.
4. Take the payment on the new loan and subtract the payments for taxes and insurance there too (again, they won't change whether or not you refinance).
5. What do you have?  The numbers that will tell you what the transaction will cost you - in other words, what you're investing; and what your return will be on that investment.

Let's look at an example:

• The principal and interest payment on your existing mortgage is $1,500  per month.
• The p & i payment on the new loan is proposed at $1,300 per month.
• The cost of the transaction (your investment) is $3,500.
• The annual p & i savings is $200 X 12, or $2,400 - think of that as your "return on investment".  
• $2,400 divided by $3,500 = 68.6%. 

In this example, you're looking at a zero risk "return" on the money you invested in the transaction of almost 70% year-after-year.  Now before all you finance majors call me to remind me that this is not a true ROI (Return on Investment) calculation . . . I know that.  It doesn't consider that you're probably looking at a new 30 year term.  It's not a true IRR (Internal Rate of Return) calculation because it doesn't consider the time value of money; it's not a NPV (Net Present Value) calculation for the same reason.  . . . but it is a good way to think about whether or not to refinance your mortgage today.

You need to answer the simple questions "what does it cost and what do I get?"  If the person you're talking with can't or won't provide these answers for you, go find someone else to talk with - they don't deserve your business because either they're ignorant or they're trying to kid you.  This ain't brain surgery folks; unfortunately, mortgages can be complicated and we can lose track of the forest for the trees.  If you focus on the "what does it cost and what do I get" pieces though, you'll stay on the right path.

. . . of course you could always call us and we'll happily walk you through it - we get paid to do stuff like that   :o)

Enjoy "the dance" - rc 

Here's another timely piece by the econ. department of Universal Lending up in Denver.  Universal is a business partner of ours and this particular article contains important concepts driving mortgage interest rates today . . . particularly if you're a Realtor with clients who have decided to wait for lower interest rates before they buy - rc

"Contrary to the conviction of deeply confused civilians and reports by lazy news media, mortgage rates are unchanged, about 5.75% for the lowest-fee 30-year paper. If you don’t believe us, visit www.freddiemac.com and its weekly survey. It is unbiased by sales jive, although it suffers from “survey lag” (early-week data released on Thursdays always misses real-time reality), and assumes a fractional origination fee. Last week’s “5.48%” captured the one-day hysterical bottom when the industry could not log onto rate-lock websites. Last Thursday’s “5.68% plus .4% origination” is still about right, and all but identical to the prior week’s “5.69% plus .5%.”

Yet, the media refer constantly to “dramatically lower mortgage rates.” They are better, but... drama? Freddie’s average for the whole of 2007 was 6.34%. A half-percent drop is nice for buyers, and a help to a few refinancers, but no fire sale.
“How can it be the same...!?!” says the client, after a cumulative 1.25% cut at the Fed in only eight days?  Answers follow.

Brand new January economic data are not that bad. Says here not bad enough to justify the Fed’s panic, let alone to anticipate more cuts. Payroll
growth slipped to flat in January (negative 17,000 is within the huge range of error and revision), unemployment down to 4.9% in a workforce statistical quirk -- soft, but hardly a recession. The purchasing managers reported their first gain in six months, likewise soft, but with persistent strength in foreign orders. 4th quarter GDP grew by a mere .6%; however, aside from a temporary drawdown of business inventories grew at 2%.

The Fed’s form is disturbing to long-term investors. Central banking is not figure skating, but Mr. Bernanke has departed his predecessor’s 17 years
of gradualism for lurching on the rink. A Fed that will lurch down will lurch up.

 
Investors bought long Treasurys and mortgages at these levels 2002-
2004 because Mr. Greenspan said after every meeting into 2006: Excessive
monetary stimulus most likely will be “removed at a measured pace.”
Translation: you’re safe for now, and we’ll give you time to get out before
we kill you.

In those late Greenspan years, deflation was the problem. Today, inflation is rising all over the world. Australia, 16-year-high 3.8% core; Europe 14-year-high 3.2%; UK 2.6% core; China 6%-plus, and an economy completely out of control beginning to export inflation to us. Each time the Fed has lurched to a catch-up ease, all the way back to August, it has rescued stocks, commodities, oil, gold, and tanked the dollar.

We have chewed on the Fed for its inaction and credit-wreck oblivion.
However, this situation is NOT a monetary problem: it is a bankingsystem
near-insolvency that may morph into a recession, each making the other worse. The crying need for six months has been transparency of credit loss and bad-asset firewall. Cuts in the overnight cost of money may intercept recession, but inflation means that these cuts cannot be maintained or
removed at a measured pace.

A central bank chairman must be prepared for the ultimate sacrifice: no tough inflation problem was ever solved by slow growth. It takes a recession. It takes higher unemployment and crushing the commodity spiral. To get
long-term rates down, Mr. Bernanke must get the good out of this slowdown:
he must let it get ugly. Instead he has rescued inflation-pushing markets again and again.

 
Two non-Fed forces holding up mortgage rates: credit fear about Fannie and Freddie has the spread between mortgages and the all-defining 10-year
Treasury (3.57% on the 1st) over two percent for the first time ever. Second, somebody by accident may arrive at an effective credit-wreck bailout: the giant bond insurers, Ambac and MBIA may be resolved in days. If no collapse, then credit fear will give way to inflation fear.

The Fed’s cuts have had a dramatic effect on ARM adjustments, and should
revise estimates of housing doom to the better -- also reducing bond-market
fear. This month, common one-year Libor-floating loans will adjust DOWN
to 5.125%."

Economic Notes is published weekly
by the Economics Department of
Universal Lending Corporation as a
service to Colorado Real Estate
professionals. © 2008, all rights
reserved.