Rate Watch #717 Long-term Effects of Deficits.

April 9, 2010
by Dick Lepre
dicklepre@rpm-mtg.com
www.loanmine.com

Product	Rate	Points	Est. APR*
CONFORMING LOAN PRODUCTS (Loans less than $417,000)
30 Year Fixed conforming
	5.125%	1.00	5.29%
	5.25%	0.00	5.32%
15 Year Fixed Conforming
	4.25%	1.00	4.51%
	4.50%	0.00	4.61%
JUMBO CONFORMING (Stimulus) LOAN PRODUCTS (Loans greater than $417,000 and less that the new amount for your county)
30 Year Fixed Stimulus
	5.5%	0	5.58%
	5.25%	1.0	5.41%
15 Year Fixed Stimulus	4.875%	0	4.98%
	4.75%	1	5.03%

* conforming loan limits for 2009 are:

1 unit $417,000
2 units $533,850
3 units $645,300
4 units $801,950

Note that the above table now means something different than it used to. "Conforming" now means "traditional conforming" (<$417,000 for SFR is the new jumbo-conforming which depends on county.) You can find the new Jumbo-conforming limit for your county here. That page says "FHA" but those amounts also pertain to FNMA & FHLMC.

You must not read these as quotes because the rate and price which you will get depends on your precise situation and is affected by, but not limited to, the following factors: credit scores, property type, occupancy, income, value of property, length of time of the rate lock, whether of not values in your area are declining, and cash out (if refinancing).

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II) Fundamentals

Initial Jobless Claims were 417,000 last week. This is higher than previous and consensus. It should serve as a reminder that restoring jobs is much harder than restoring GDP. ISM services - 55.4, consensus 53.6, previous 50.0. Pending Home Sales - +8.2%, consensus -1.0% previous -7.8%.

III) The Technicals

The daily and weekly tech are both bearish (lower prices, higher yields). The daily should upcross to bullish next week but the bearish weekly will restrain any gains.

For those who are not long time readers, the basis for these observations about technicals is the work of Jim Grauer which can be viewed at StoMaster.

IV) Analysis

I read a bit of the Citicorp grilling this week and it is interesting how people miss one of the key elements which nearly destroyed many large banks. The Basel I accord of 1988 was an attempt to set standards to determine what constituted adequate capitalization for banks. I want to discuss only mortgages. Under Basel I a bank had to maintain $4 in capital for every $100 of whole residential mortgages it owned. But a bank only had to maintain $2.00 in capital for every $100 worth of GSE (FHLMC/FNMA) debt it owned. Banks decided to leverage their capital by selling whole loans and buying GSE debt at the precise time as GSE debt had been poisoned by HUD's insistence that the GSEs make a larger number of risky subprime loans. If a bank originated $1,000,000 in mortgages, $40,000 of capital was tied up. It could sell that $1,000,000 in loans to FNMA and buy back $1,000,000 in FNMA paper and tie up only $20,000 in capital. Banks decided that it would be more profitable to double their leverage with FNMA debt. They were sadly mistaken. The ironic tragedy is that rules put in place to guarantee that banks held enough reserves had precisely the opposite effect. This was downright Shakespearean. Banks knew the quality of the whole loans which they originated but decided to trade that valuable and familiar asset for HUD-mandated GSE paper comprised of too many mortgages destined to default.

I want to thank Jeffrey Friedman, editor of Critical Review for helping bring this to the surface. Friedman has a book called Causes of the Financial Crisis, forthcoming from the University of Pennsylvania Press.

 

V) Where Are Rates Headed?

This is an issue receiving too little attention. A couple of weeks ago one bad Treasury auction seemed to undermine support for Treasuries and sent yields up about 0.25%. While we were talking about mortgage rates going up because the Fed exited as a buyer, mortgage rates also went up as a result of Treasury Yields rising. In a twisted sense the good news is that investors took up MBS slack even when things were getting dicey.

I believe that some people are coming to their senses and recognizing that the U.S. cannot afford to keep running $1 trillion deficits without a major disruptive effect. The fact that there is no political accountability makes all of this possible. We are going to have to pay interest on this massive debt and, in addition to Treasury debt, no one has taken seriously the shortfalls in Medicare and Social Security. To make this even worse the Medicare and Social Security Trust funds exist only on a balance sheet. The funds have almost entirely been loaned to Treasury and spent. Future tax receipts have to keep the government running, pay interest on the national debt, and pay back the money borrowed from the trust funds. In addition no one really knows about the fiscal effects of the new health care bill.

Significant GDP growth may occur only as the result of a Ray Kurzweil-like technological breakthroughs which provide very significant pop to GDP. Some of the complacency exists because we believe we have been in this jam before and gotten out. Those of you old enough to remember the last scene of "Butch Cassidy and the Sundance Kid" know how this ends.

Neither political party seems to have the least intent to actually practice fiscal sustainability while in power. Each party comically criticizes the other for deficit spending when they are out of power but engages in deficit spending when it is in power. Politicians know that higher taxes or less spending is the path to not getting reelected so, in a sense, one can lay the blame on the voters. Politicians and the media are dismissive of the "tea party" movement and miss the entire point of what it is. The tea party movement is not politics, it is anti-politics. It is a version of libertarian thinking in line with the more sophisticated Cato Institute. At present, it is primitive and disorganized. It does not have the organization to deal in a timely manner with criticism from politicians and the media.

I am not merely ranting here. I am stating that the utter inability to address fiscal sustainability will lead to a very dismal economic future and potential social disruption. If enough people perceive the government as being too large and intrusive and expensive as taxes inevitably rise, the tea party movement could morph into a populist libertarian party calling for less government spending and less government intrusion into our personal lives. Libertarians believe in less government spending, but they also believe in relaxation of social intrusions which means, for example, much more lenient drug laws. I don't know if "Stoners and Conservatives Unite" will fly, but what the heck.

I find it interesting that myself and Jurgen Brauer proposed a modus for the government to achieve fiscal sustainability which would, in fact, enable the political two-party status quo to maintain. Not enough politicians or even media people recognize that absent such a plan for fiscal sustainability, extremely serious financial and political disruption will inevitably occur.

If you have something to add to this discussion please post a comment on the blog.

 

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Dick Lepre
RPM - SF
435 Pacific Avenue #350
San Francisco, CA 94133
DRE License # 01143973
dicklepre@rpm-mtg.com
Web site: www.loanmine.com
Blog: economy.typepad.com
(415) 343.6789 (direct dial number)
(415) 244-9383 (cell)
(866) 488-2051 fax

California Department of Real Estate - real estate broker license #01201643