Fed Planning Exit…higher rates coming?

The Federal Reserve yesterday released an outline of their plan to remove the financial marketplace from the supportive influences of accomodative policy. Part of this outline included a statement on the fate of the Agency MBS Purchase Program.

Here are the comments:

“The Federal Reserve purchased $300 billion of Treasury securities and currently anticipates concluding purchases of $1.25 trillion of agency MBS and about $175 billion of agency debt securities at the end of March”

Plain and Simple: NO CHANGE IN TONE FROM BERNANKE ON THE END OF THE MBS PURCHASE PROGRAM. Funds are still on schedule to run out at the end of March.

While this is a necessary step in the overall recovery process, there will still be consequences to manage.

Even though we have been reminded that the Treasury is providing confidence boosting, the general “up in the air” condition of Fannie and Freddie combined with the loss of Federal Reserve MBS funding are expected to push mortgage rates higher. 

The timing of this move has increased nervousness about the outlook for housing. The Fed will be exiting the mortgage market just as the spring/summer home buying season is expected to pick up steam. Naturally, the question everyone wants addressed is:

HOW MUCH WILL RATES RISE?

Without going into servicing valuations and best executions options, mortgage rates are dependent upon the mortgage basis. The mortgage basis can be generally thought of as a guidance giver for mortgage rates. Rates will generally be a factor of:

1. The direction and movement of benchmark Treasury yields
2. The perception of risk in holding mortgage-backed securities as an investment (loss of principal investment)
3. Supply and Demand in the agency MBS market

Plain and Simple: the Fed’s asset purchases reduced interest rate volatility.  Lenders do not like interest rate volatility….less of it helps keep mortgage rates low relative to Treasury yields. Because the Fed is not planning on offloading their holdings anytime soon, interest rate volatility should remain low.

But do mortgage rates even matter ?

Yes they matter, but not as much as most think. Rates are low right now and many analysts are calling for higher rates in the near future…that should be boosting home buyer demand right now, before rates rise. Yet purchase demand continues to put along near 12 year lows. Low rates are not helping right now…will they make much of a difference in two months? While mortgage rates are easy to pin the blame on, the problem runs much deeper than borrowing costs. 

Housing needs qualified borrowers, its all about JOBS JOBS JOBS!

Short Sales…will they become less of a headache?

The biggest mystery to me over the last eighteen months was why banks weren’t more receptive to the ‘short sale’ process. Studies have shown that it costs the bank more money if a property was foreclosed upon than if they accepted a ‘short sale’. For homeowners, a ‘short sale’ makes much more sense for several reasons:

• There is a much higher chance that the deficiency judgment could be negotiated in a short sale versus a foreclosure.

 • A short sale would have less of a negative impact on the homeowner’s credit rating.

• The homeowner would have at least some control over the timing of their relocation to new living arrangements.

• A ‘short sale’ would allow the homeowner to leave with dignity.

So, if it would be better for both the bank and the homeowner, why were more ‘short sales’ not completed? A recent research study by The National Consumer Law Center (NCLC) has uncovered the mystery behind this dilemma. In order to understand it, we must first look at the differences in the banking industry over the last ten years.

In the past, the banks used to process the loan (take the application, put together the file, etc.), lend you the money, and also service the loan (send the bills, make collection calls, follow-up, etc.). Over the last eight to ten years, the lending of mortgage money has shifted. First Wall Street and then the federal government became the primary lender in the mortgage sector. But, neither Wall Street nor the government had any interest in processing or servicing the mortgage. Mortgage companies continued to process the loans, but a new industry was created to fill the need for the servicing of these loans. So now, a separate and independent entity is servicing a tremendous portion of existing mortgages.

Just ten years ago, 37.4 percent of all mortgage loans were securitized (thus requiring a servicing company). Today, that number is 79.3 percent. The NCLC study shows that the reason more houses are not available for ‘short sales’ is because these servicing companies actually collected more fees for a foreclosure than they did for a ‘short sale’. Actually, the servicing company would lose money if they did a ‘short sale’. Since they were now in charge of making that decision, it was obvious why foreclosure was the alternative of choice.

The federal government realizing that modifications were not the answer and banks realizing that the foreclosure process was too expensive, have agreed to change the fee structure to make it more profitable for the servicing companies to lean toward ‘short sales’.

It’s always about the money. This situation was no different. Now that the money will flow to the companies that choose the ‘short sale’ alternative, watch how much easier the ‘short sale’ process will become.

Why now?…..here’s why

Anyone looking to buy, move-up or refinance, MUST do it before the spring. Let me explain why I feel this way. Banks are not currently in the business of lending money to home purchasers. Why? Because, with all the risk associated with mortgaging and with inflation looming why would anyone make a 30 year loan at 5%? So banks, for sometime now, have been content to just collect the up-front fees associated with the loan and the processing fees associated with servicing the loan (billing, collection, etc.). The actual loan is financed by the government who has been willing to make loans at a lower rate in part to help stabilize the economy.

Well, the Fed announced last week that they will no longer be buying those mortgages after March of 2010.

Once the government stops purchasing mortgage-backed securities and banks are forced to make the loans, rates will rise. History tells us that once they start to rise they will do so quickly and dramatically.

Again, if you are going to buy, move-up or refinance, DO IT NOW!

MBS & Wall St.

The anchor/pundits on CNBC (Larry Kudlow I’m talking about you) and other TV business shows have been blathering on all week about how the government needs to wean itself from not only Fannie and Freddie but the mortgage market in general. I got news for you, Larry: the private label MBS market ain’t coming back any time soon and when it does it will be for low LTV jumbo mortgages with high FICO scores. Wall Street will never again securitize subprime loans unless there is some type of government backing on them or tons of mortgage insurance or something similar.

Market Review…last week

Investor sentiment about the economic recovery fell last week, and the stock market declined. Expectations for slower economic growth are favorable for bond markets, including mortgage-backed securities (MBS), and mortgage rates ended the week a little lower.

The important monthly Employment report showed mixed results. Against a consensus forecast for a loss of -225K jobs in August, the economy lost -216K jobs. This was the smallest level of monthly job losses since August 2008 and was far below the monthly average of -691K seen during the first quarter of the year. The biggest surprise in the data came from the Unemployment Rate, which jumped from 9.4% to 9.7%, the highest level since 1983. The unexpected increase was mostly due to previously discouraged workers returning to the labor pool to look for jobs. Average Hourly Earnings, a proxy for wage growth, rose at a moderate 2.6% annual rate.

The future of Fannie Mae and Freddie Mac made the headlines this week when the Mortgage Bankers Association (MBA) released its restructuring proposal. While the MBA suggested the elimination of the two agencies, it would replace them with new entities which would perform many of the same functions, with many of the same people. Its plan would maintain a government guarantee of principal and interest for MBS investors. The two agencies have played a pivotal role in keeping mortgage rates low and in expanding homeownership, and the MBA proposal would retain these benefits. It’s very early in the process, and the Obama administration indicated that its proposals for Fannie and Freddie may not be revealed until early next year.

Treasury auctions may have the greatest impact on mortgage rates this week. There will be $70 billion in 3-yr, 10-yr, and 30-yr auctions on Tuesday, Wednesday, and Thursday. It will be a light week for economic data. The Fed’s Beige Book will be released on Wednesday, and the Trade Balance will come out on Thursday. Import Prices and Consumer Sentiment are scheduled for Friday. Mortgage markets will be closed on Monday for Labor Day.

Update on non-Performing Loans

At the end of last week there were inside discussions about the nonperforming loan market including a rumor that the FDIC might be offering for auction a $1.4 billion package of troubled whole loans, including some FHA product.  As one nonperforming loan investor said, “They have a bunch of that crap to sell.”  Bank of America has been quietly disposing of some of its troubled whole loans (which likely came from Countrywide) by selling them to two different hedge funds, one of those hedge Funds is Waterfall. (At least $2 billion may’ve been sold.)

Closing Costs

Yesterday a homeowner asked me why they have to pay closing costs such as recording fees, processing fee, underwriting fee, etc… even though they were going through their current lender.  Their thought was since they already have the loan why do they need to be charged these fees again.  The reason for this is that more than likely whoever you are making your mortgage payment to does not own your mortgage.  They are the servicer of your mortgage meaning they send you the bill, collect your money, manage your escrow account and update the credit agencies.  When they receive your monthly payment, they cash your check and forward your money to the end investor that actually owns your mortgage, which could be a Wall St. Hedge Fund, Investment Club in China or Bank in Hong Kong…etc.  They do keep a small portion to cover their expenses and make a profit for servicing the loan.  So even though you might be going through your current lender, you will have to pay these fees again because you are basically doing a new loan.

If you do not want to pay these fees, you can elect to do a no cost loan.  A no cost loan does not mean that there are no costs, rather it means the lender you are doing the loan with is paying them for you.  How they do this and still make a profit is by premium pricing which means they are giving you a higher than par rate.   A par rate means that the lender is not being paid on the back side to do your loan, so that is why when I quote a par rate I state that you must pay all costs including one point loan origination/discount/broker fee.   If you are keeping your home short term it would be better to pay less costs and secure a higher interest rate.   If the par rate is 5.00%, as a consumer you can elect to take a higher rate and with the money your lender is being paid for giving you a higher than par rate they can pay your fees for you and still make a profit.   Generally speaking you should expect a rate anywhere from .50% to 1.0% higher for a no cost loan.

The par 30 year conventional rate mortgage is in the 5.00% to 5.25% range for the best qualified consumers.  In order to qualify you must have a FICO credit score of 740 or higher, a loan to value at 80% or less and pay all closing costs including one point loan origination/discount/broker fee.   As always, you can elect to pay less in fees and take a higher interest rate.  I recommend to my clients if they are keeping their home for more than 7 years to pay all the costs to secure the best rate which over time will save them much more in interest than the upfront costs.

How long have MBS been around?

 A friend asked me some questions about Mortgage Backed Securities…one thing he asked was. How long have they been around?  He was surprised that most of my trading of MBS within our Hedge Fund was in the early ‘90s.  Many think this is something relatively new to the world markets.

So how long have Mortgage Backed Securities (MBS) been around? You could say 71 years…thank you FDR.

In 1938, a governmental agency named the National Mortgage Association of Washington was formed and soon was renamed Federal National Mortgage Association (FNMA or Fannie Mae). It was chartered by the US government as a corporation which buys Federal Housing Administration (FHA) and Veterans Administration (VA) mortgages on the secondary market, pools them, and sells them as “mortgage-backed securities” to investors on the open market. FNMA was later privatized.

Certain old-time Wall St. traders and Lawrence White of the Stern School of Business at NYU says 1970 is when the first MBS was sold.

From its beginning, the issuance of MBS in the U.S. has been dominated by governmental and quasi-governmental entities, although “private label” MBS have been growing in relative importance after a late and slow start. The experience of MBS in the U.S. began in 1970, with MBS issued by Ginnie Mae. Freddie Mac, newly created in 1970, issued its first MBS in 1971. Fannie Mae, though in existence since 1938, issued its first MBS in 1981. Finally, the first “private label” MBS was issued in 1977, by Bank of America.

Lets go with the 1970 number, that means that MBS have been around for 39 years

Did the government create MBS?

MBS are a result of government monkeying around in the home loan market. Ginnie Mae stands for the Government National Mortgage and is a government Agency. Fannie Mae was a government agency that was created in 1938 and was later turned into a government sponsored entity and Freddie Mac was a late comer to the game but is similar in nature to Fannie Mae. According to Professor Lawrence White the first MBS was sold by a government agency, Ginnie Mae.

Second the government, through Ginnie Mae, and also implicitly through Fannie Mae and Freddie Mac guarantee home loan payments.

In 2007 government MBS were almost 8 times that of non-government MBS…enough said.