R C's Blog

So – why on earth are jumbo rates so high? . . . and what about that conforming jumbo loan deal that was supposed to provide some relief?

First things first. Fannie and Freddie are limited by charter and regulation from providing jumbo loans. Their maximum loan amount ($417,000 here in E.P. county and much of the rest of the country) is set by median sales price formulas. Fannie, Freddie, and Ginnie (GNMA specializes in fha and va loans) historically provide liquidity to the mortgage market by buying loans from lenders, then securitizing the loan pools and selling those securities to investors.

About 5 to 7 years ago (sorry, didn’t look it up) Wall Street got into the game by doing the same thing – purchasing and securitizing mortgages – only they didn’t play in the GSE’s backyard, they invented and bought loans we had never even heard of . . . alt-a, sisa, nina, pay-option arms, etc. The securities Wall Street sold were insured by third party companies and rated by ratings agencies. This, in effect, became the private-sector mortgage backed securities market we’ve heard too much about this year.

Problem was – that private sector was also where jumbo loans had historically gone to be securitized. When wall street’s house of cards came crashing down this year, it brought jumbo loans with it. Jumbo loans are still available, but confidence in privately-issued mbs (mortgage backed securities) has been so shattered that it now takes much larger rate premiums to attract capital to non-agency mbs issues – which includes jumbo loans. (non-agency means not FNMA, FHLMC, or GNMA).

And how about the “conforming” jumbo loans that Congress temporarily authorized Fannie and Freddie to buy earlier this year?

. . . sorry, only for designated “high-cost” markets, like Boulder County and some of our resort communities – definitely not El Paso county. They haven’t been very successful anyway, but that’s for another time.

So what to do when you’ve got a million dollar house, 20% down, good credit, etc.? Try to convince your buyers that it’s smart to pay-up on a mortgage because “the Street” screwed up the markets? Probably won’t get far with that model. The good news is that the huge spread between rates on conforming and jumbo loans isn’t really very large until you hit the 30 year fixed. Here’s what I mean:

Conventional                     Jumbo

3/1 arm – 6.25%             3/1 arm – 6.50%

5/1 arm – 6.625%           5/1 arm – 7.00%

7/1 arm – 6.75%             7/1 arm – 7.50%

10/1 arm – 7.125%          10/1 arm – 8.25%

30 yr. fixed – 6.75%         30 yr. fixed – 8.75%

So the longer the rate is contracted for, the larger grows the spread between the conventional conforming rate and the jumbo rate. The optimist in me thinks that I’d probably go for the 5/1 jumbo arm – after all, the rate spread is only .375% and surely the markets will have stabilized and become more liquid by the time my loan resets – so then I’ll refinance into a “saner” 30 yr. fixed loan. The problem with that thinking, of course, is that it makes the famous economist’s assumption of “all things being equal” . . . things like our interest rate environment will be just like it is today, like we’re not living in an energy-driven inflationary spiral, etc. Therein lies the risk, and that’s exactly why you see the spread widening as the promised rate period lengthens.

Hope that makes some sense.  If not, or you have comments or additional questions, don't be shy about using the comments feature below. 

 . . . remember the old saying "first, figure out what's wrong . . . next, figure out someone else to blame"? 

OK, I'm kidding, the author doesn't actually blame George, a'la climate change, gas prices, etc.  I just wanted to get your attention on the attached artical which, I believe, is the best explanation I've yet seen on the mess we're in today.  It's well written and the study quoted is based on research, not opinion.

In the credit where credit's due department, this is from the Housing Wire's website.  Their link follows the artical.

Learn and be amazed.

Regards, rc

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Subprime Lending Not to Blame For Credit Mess, Says Study
Posted By PAUL JACKSON On July 30, 2008 (8:59 am) In Featured-front, Origination/Lending

It’s almost taken as common knowledge at this point that out-of-control subprime mortgage lending — the funding of home loans to borrowers with less-than-perfect credit — was the chief culprit behind the unsustainable boom in U.S. home prices that eventually derailed the real estate and mortg age markets.

But new research, published Wednesday by UC Irvine’s Paul Merage School of Business Center for Real Estate, suggests that subprime loan products themselves may not have been the primary cause of U.S. home prices’ rise and fall.

Instead, the study argues that the considerable 2003 pullback of government-sponsored financial service corporations Fannie Mae (FNM: 12.20 +5.17%) and Freddie Mac (FRE: 8.85 +5.11%) from the mortgage credit market and their subsequent replacement by aggressive, private mortgage securities issuers in late 2003 had a significant impact on home prices and was more responsible than subprime lending for the drastic price runup that peaked in early 2006.

“We were quite surprised to find the intensity of subprime lending was insignificant after controlling for all the other factors influencing the market, but we were really blown away when Fannie’s and Freddie’s continuing presence in the market was shown to be so important,” said Kerry Vandell, UCI finance professor and Center for Real Estate director.

Vandell, along with Major Coleman IV, a finance doctoral student, and Michael LaCour-Little, a Cal State Fullerton finance professor, used 1998-2006 housing and mortgage data from a variety of sources — including First American LoanPerformance, the S&P/Case-Shiller Home Price Indices and the Federal Housing Finance Board — to analyze 20 U.S. metropolitan areas as part of their study.

The researchers found that rising home prices up to 2003 could be explained by economic fundamentals, such as low unemployment rates, expanding household incomes and population growth. These factors fueled housing demand and, in turn, increased U.S. home prices. During this time, Fannie Mae and Freddie Mac actively issued and purchased conventional, conforming mortgage-backed securities.

But in 2003, political, regulatory and economic factors–including accounting irregularities that led to their senior officers’ resignations and the capping of their retained loan portfolios–forced the two entities to significantly slow their lending volume. Private funding in the form of asset-backed securities and residential mortgage-backed securities replaced conventional, conforming mortgage-backed securities as the prevalent source of mortgage capital.

The new credit environment allowed looser underwriting standards and increased tolerance for riskier, high-yield loan products, the study’s authors said. It also birthed a borrowing climate that sought to provide previously marginal borrowers with additional access to credit — a movement that was heartily endorsed by the Bush Adminstration, who actively pushed its vision of “the Ownership Society” at that time, as well.

This fundamental credit market shift led to a record increase in total mortgage volume, and pushed up home prices with momentum characteristic of a bubble.

The researchers also determined that interest rates did not significantly affect house prices. The finding defies conventional wisdom that ties interest rates directly to the monthly cost of housing and assumes an effect on purchase prices.

“These findings help us understand that the government can have a major role in affecting the mortgage and housing markets,” Vandell said. “It’s important policymakers consider this influence when they attempt to shape the markets in the future.”

And, in other words, Fannie Mae and Freddie Mac may yet matter more to our mortgage markets than some in the industry might otherwise want to admit.

Disclosure: The author was long FRE, and held no other relevant positions, when this story was published; other indirect holdings may exist via mutual fund investments. HW reporters and writers follow a strict disclosure policy, the first in the mortgage trade.

Article taken from Housing Wire - http://www.housingwire.com
URL to article: http://www.housingwire.com/2008/07/30/subprime-lending-not-to-blame-for-credit-mess-says-study/