A Better Mortgage

The Week Ahead in the Capital Markets

2008-02-11T18:23:00-06:00

We have a world class secondary market department and they are kind enough to send out weekly updates to us sales monkeys. I like posting it as it is both a great source of technical and anecdotal information. Please let me know your thoughts!

The Week Ahead in the Capital Markets - February 11, 2008

Stuck in the middle with you. More evidence of recession pushed short-term rates lower and fears of stimulus-led inflation pushed long-term rates higher. Fixed mortgage rates are somewhere in the middle, and didn’t change much. The two-year Treasury yield closed the week below 2.00%, and amongst other things, a weak Treasury auction (where investors balked at super-low yields) sent long-term rates soaring.

“Odds for more rate cuts have done nothing but increase, and traders have begun rumors of another rate cut prior to the March 18 FOMC meeting. April fed-funds futures place 100% probability on a 0.50% cut to 2.50%. There is a 30% chance the Fed will cuts rates by 0.75% by then. Chairman Bernanke speaks before Congress on Thursday about monetary policy.

Bankers cheered lower funding costs brought on by the steepening yield curve. The curve is as steep as it has been in several years, closing the week at +1.72%. With more short-term rate volatility on the horizon, mortgage rates remain historically high relative to Treasury yields.

Fixed rate jumbo mortgage rates have not improved, and jumbo prices are withering around three points behind conforming prices. Effects of the expanded loan limits in the government stimulus plan are not certain, and the higher-limit loans are unlikely to trade at the same prices as their conforming brethren. In related news, Countrywide Securities let go a large group of professionals due to substantially-reduced levels of activity.

In other news, have you seen www.youwalkaway.com? The website offers borrowers help/advice on how to “walk away” from their mortgage obligations. What a world.”

Stocks had another tough week. They’re off 15% from the October highs. In Barron’s this weekend, an investing icon, Jeremy Grantham (his firm manages $150 billion), offered some advice for the year ahead. He thinks the market will bottom in 2010, and “trend-line value” puts stocks about 15% lower by then. The fourth year of a presidential cycle, where you have a lame-duck president, is usually not good, and we should expect the market to fall about 5% for the year. The first year of a new presidency, especially one where the party in power changes (no predictions here) usually ends up with the same thing: a market decline on the order of 5% or so. If you’re going to stay in the stock market, “value is cheaper than growth,” according to Grantham.

From David Letterman's Top Ten Reasons Mitt Romney Dropped Out of the Presidential Race: #4, Apparently America is not ready for a white male president. #3, There is that thing about not getting any votes. And #1, He lost all of his money betting on the Patriots.

The Week Ahead in the Capital Markets

2008-01-28T14:29:00-06:00

The Week Ahead in the Capital Markets - January 28, 2008

“That was a nice refinance boom we had Wednesday morning, although I wish it had lasted a little longer,” said more than one mortgage banker. As the bond market soared to new heights, conforming fixed note rates were available at or near 5.00%, touching off an avalanche of mortgage origination. “Wednesday was one of the biggest days the industry has ever seen,” said one trader. It was an especially memorable day in light of the doldrums that the mortgage business has endured in recent months.

“If you were out last week, you must wonder what all the fuss is about. After all, mortgage rates only fell 0.02% for the week (never mind the several-point rallies and sell-offs in between), and stocks rose a modest 108 points (never mind the 1000-point range in between). Along the way, the two-year Treasury yield fell briefly to 1.85%, and Fed Funds futures signaled sub-2.00% funds rates later this year.

For this week’s Fed meeting, there is an 82% probability for a 50bp cut to 3.00% and 28% probability for a 25bp cut to 3.25%. The Fed’s surprise 0.75% rate cut on Tuesday, and the prospect of a government-led economic bail-out, quelled some panic in the markets and returned stocks and bonds from their extremes. Much of the talk swirling around the mortgage industry centered on the higher conforming loan limits proposed in Bush’s economic package. Jumbo fixed rates, meanwhile, continue to worsen, and ended the week nearly 1.00% higher than conforming rates (more than three points worse in price).

The spread between mortgage and Treasury yields hit 2.40% last week, close to record highs of 2.60% set in late 2002. This spread is driven by many factors, not the least of which is interest rate volatility. When rates settle down (i.e. when the Fed is not expected to cut or raise rates any time soon), look for this spread to collapse, producing relatively lower mortgage rates.

Lower short-term funding costs widened the difference between two-year and ten-year Treasury yields to +1.40%, resulting in the steepest yield curve we have seen since late 2004.”

“’Beans in the teens!” was the cry heard in Chicago. The reference is to soybeans trading at $13.00 per bushel. ‘Beans set a record of $13.45 earlier this month, and were up 78% last year. More acreage was devoted to corn (for ethanol production) this year than at any time since 1944. Add some weather problems in South America and the U.S. Midwest, and you have a recipe for very high soybean and wheat prices.

Tucker Carlson said on MSNBC the other day that John McCain and his wife Cindy went along with Fred Thompson on his honeymoon. Now, look, I knew Fred Thompson didn't like to work hard, but bringing another guy on the honeymoon? Come on. That is just plain lazy. – Jay Leno

The Week Ahead in the Capital Markets

2008-01-14T10:00:00-06:00

The Week Ahead in the Capital Markets - January 14, 2008

“I don’t like the mortgage business.” – Ken Lewis, CEO, Bank of America

Lewis offered $4 billion for Countrywide because of its “extraordinary value” at the price. The deal is intended to close in July or August. The mortgage business heaved a sigh of relief as the prospect of a near-term Countrywide bankruptcy evaporated.

The B of A deal removed some uncertainty from the financial markets, but huge Fed rate cuts are still widely expected. Fed funds futures have declined 0.50% in two weeks. Fed policy hinges on financial market risks, and the levels of inflation and growth. Lately it seems that markets are stabilizing, inflation is accelerating, and growth is slowing. In speeches last week Fed Chairman Bernanke and Fed Governor Mishkin telegraphed the Fed’s concerns about financial market risks, and the need to pre-empt any downside risks to growth. Inflation does not appear to be an immediate concern. In short, the odds for a 0.50% rate cut this month jumped to 90%, and odds favor another 0.50% in March. Fed funds futures signal a funds rate of 2.60% by the end of this year.

“As more rate cuts were built in to the yield curve, short-term rates fell 0.10% more than long-term ones, and funding costs fell accordingly. The difference between mortgage and Treasury yields remained steady. The spread has not widened appreciably in three months, and mortgage bankers are enjoying a healthy decline in mortgage rates. Lock volume was strong last week, and refinance activity is picking up.

Servicing prices have moved in to two camps: a high-priced one that believes the record slowdown in prepayment speeds is here to stay, and a relatively low-priced one that believes speeds will accelerate soon. Prices for conforming whole loans, therefore, are as widely scattered as we have seen in some time.

Jumbo fixed rates continue to languish at approximately 0.75% over conforming rates, and rumors swirled last week about a temporary increase in agency lending limits. The Mortgage Bankers Association has changed course and is now backing stand-alone legislation that would allow Fannie Mae and Freddie Mac to purchase jumbo loans up to $625,000 nationwide.”

Not such good news for John Edwards. He came in third. Third. Proving, yes, there are two Americas and neither one is voting for him. – Jay Leno

The Week Ahead in the Capital Markets

2008-01-07T10:18:00-06:00

The Week Ahead in the Capital Markets - January 7, 2008

“Stand by for a tumultuous 2008 as the market struggles to move from the shadows back into the light of sounder banking… accompanied by Fed Funds levels at 3% or lower.” – Bill Gross.

“Mortgage rates are now officially low. Conforming loans with rates in the low-to-mid 5% range are streaming in to pipelines. Mortgage rates fell 0.55% in the past two weeks alone, and thirty-year fixed rates are near levels where they spent much of 2003 and 2004. The spread between mortgage and Treasury rates has stopped widening for the moment. Therefore as Treasury rates dropped, mortgage rates came down. Mortgage yields traded about 2.10% over equivalent Treasuries in the past few weeks.

While credit is still tight and property values very much in question, we expect loan volume to pick up nicely this week. It has been seasonally low for the entire industry. Loan volume is usually about half of its usual pace over the holidays, and this time around was no different.

Jumbo fixed rates continue to languish. Prices are about 2 ½ points behind equivalent conforming loans, and rates hover at historical wides, roughly 0.75% over conforming rates. The jumbo market remains a tale of two investor types: portfolio jumbo ARM rates are aggressive as funding costs drop and banks seek to fill portfolios; jumbo fixed rates are high as the securities market struggles along, offering no good outlet for aggregators.

Bankers cheered as the yield curve steepened. Tough economic news pushed short-term rates down sharply. The difference between ten-year and two-year Treasuries closed last week at 1.11%.”

In the wake of Friday’s pitiful jobs report, odds predicted the Fed will cut rates to 3.75% this month and to 3.50% by March. All of this in spite of oil trading at the long-feared $100 per barrel level, and gold reaching its 1980s high of $850 per ounce.

By the way, I was thinking about this. I think now I'm the only TV host with facial hair, if you don't count the cast of “The View.” – David Letterman

The Week Ahead in the Capital Markets

2007-12-10T13:45:00-06:00

The Week Ahead in the Capital Markets - December 10, 2007

To ease 50bps or not to ease 50bps? That is the question for Tuesday’s Fed meeting. Friday’s employment report – not as weak as expected, but still pretty weak – took some steam out of the bond market and tilted the odds towards a 25bp cut. Jobs, however, reflect an economic picture that is at least a couple of months old. The Fed will put more emphasis on the current risk in the global markets, and they have to contend with year-end funding costs. The difference between LIBOR and Treasury rates is a quick measure of global risk. Hint: It’s very high right now. At week’s end, the odds for a 25bp cut stood at 100%, while the odds for a 50bp cut fell to 45%.

“Mortgage rates gave up all of the ground they had gained last week. A combination of higher long-term Treasury yields and wider mortgage-to-Treasury spreads did the trick. Jumbo spreads didn’t fare much better, and continued to widen. Spreads of all kinds remain wide, and the markets don’t seem convinced that current Fed actions or Bush’s proposal will help much.”

The Fed will cut rates and more solutions like the Bush Plan – a hastily conceived and problematic solution, as Barron’s described it – are likely to be unveiled. The most probable outcome is a mild recession in 2008. Greenspan used to say that the Fed needs to focus on the long-term threats rather than smaller near-term problems. John Mauldin opines, “The truly dangerous problem is a credit crunch. Lower rates in a credit crunch will be like pushing on a string. Think about Japan in the '90s. Even zero rates did not help.”

Stocks don’t seem to care. Oil prices are on the way down and stocks are on the way up. A reduced nuclear threat from Iran buoyed stocks – did you know gas is seven cents per gallon in Iran? The stock market is having a grand old time, enjoying the mix of lower interest rates and an economy that is weak but not too weak.

A quick look at the sub-prime securities market illustrates just how problematic a simple solution can be. Most sub-prime loans ended up in structures with ten or twenty or more credit tranches, some with floating rates, others with fixed rates. 3/4ths the tranches were usually rated AAA, and they landed far and wide, in everything from CDOs to foreign bank funds, some of which were re-rated in to securities structures of their own. To top it all off, the first lien securities are defaulting like crazy, and many securities composed of second liens have all but disappeared. Changing the interest payments that flow in to that mess will be challenging, to say the least.

“Drill for oil? You mean drill into the ground to try and find oil? You're crazy,”
-Drillers who Edwin L. Drake tried to enlist to his project to drill for oil in 1859.

The Week Ahead in the Capital Markets

2007-12-03T08:54:00-06:00

The Week Ahead in the Capital Markets - December 3, 2007

It was like kissing your sister. Yes it was a good thing that the agencies left conforming loan limits the same – if they strictly followed the housing price index, they would have lowered the loan limits. Unfortunately, so many originators were hoping for an increase to, say, $1 million that the announcement left the mortgage market feeling a little flat.

“If you needed a conforming fixed loan, last week was your week. Not so much if you were looking for a jumbo loan. Conforming mortgages soared, chopping a full 0.25% off of fixed mortgage rates. Jumbo loan prices unfortunately continued their downward spiral relative to their conforming brethren. AAA jumbo tranches continue to trade poorly, and jumbos are trading a full point worse than a month ago. Meanwhile, mortgages had a decent week relative to Treasuries; mortgage rates are still at four-year wides (2.00% higher than Treasuries), but they reversed some of their recent, dramatic ascent. And bankers have reason for hope: The yield curve is steeper than it has been in three years. And check out August fed-funds futures: 3.10%!”

In what may end up being a dead cat bounce, financials led stock indices on a tear last week. A spate of financial news – Citi receiving a capital injection, E-trade selling some ABS, Bernanke talking about a Fed ease, Paulson arguing for a sub-prime bailout – took the financial sector index up 10% from its lows. The financial stocks are still down considerably, of course. The sector has fallen back to the same level it was seven years ago.

Plenty of cat-calls met Paulson’s proposal to freeze sub-prime note rates, but broad government intervention is nothing new in times of real estate crises and illiquidity. The Federal Reserve Act and many other changes resulted from financial panics. Years ago, Fagin assured Oliver Twist that pick-pocketing was a moral thing to do. It was taking from the greedy rich and giving to the needy poor. One hundred years ago, a group of bankers met with J.P. Morgan and found a way to end the Panic of 1907. They injected cash in to the system then, and we’ll probably see more of the same before this crisis is through.

Here's what I don't understand: Rudy Giuliani had three wives and he's not the Mormon candidate? – (David Letterman)

The Week Ahead in the Capital Markets

2007-11-19T13:01:00-06:00

The Week Ahead in the Capital Markets - November 19, 2007

“Mandatory sales have been very strong relative to best efforts. The reason: mortgages are once again trading with ‘zero duration’ and hedge costs are low. When Treasury yields drop, the market thinks more rate volatility is ahead, mortgage-to-Treasury spreads widen, and mortgage rates do not change. When Treasury yields rise, the market thinks volatility will subside, mortgage-to-Treasury spreads tighten, and mortgage rates do not change. The former – rates down – has been mostly the case lately, and mortgage yields are trading a whopping 2.09% over five-year Treasuries. That’s the widest since 2003.

Jumbo core prices worsened relative to conforming in the past day or so, but not enough to call it a trend quite yet.”

Short-term rates remain volatile, and the market has begun trading at odds with Fed-speak. Fed funds futures are predicting – with 86% certainty – that the Fed will cut rates by 0.25% on December 11th. 0.75% of additional cuts are also priced in for the first half of 2008. Fed Governor Kroszner, on the other hand, said Friday that current Fed funds rates are low enough already to help the economy weather this “rough patch.” The U.S Treasury is also doing its part to assure global trading partners that a strong dollar is a high U.S. priority.

Meanwhile, “Level 3 assets” is the latest phrase to grab financial headlines, and financial stocks are getting trounced. The new accounting rule SFAS157 requires banks to divide their tradable assets into three “levels” according to how easy it is to get a market price for them. Level 1 assets have quoted prices in active markets. At the other extreme, Level 3 assets have only unobservable inputs to measure value and are thus valued by reference to the banks’ own models, according to PrudentBear.com. A number of leading banks and Wall Street firms hold sizable amounts of Level 3 assets, enough to incite fear among investors and send stock prices down another notch. As has been true with much of the mortgage meltdown, perception has trumped reality. Given that investors have little chance of understanding how these Level 3 assets will perform, most investors choose to sell.

As Warren Buffet notes, “When the tide goes out, you find out who’s been swimming naked.”

Welcome to the Dundies!! (AKA the 68th Carnival of Real Estate)

2007-11-19T06:00:00-06:00

Welcome to the 68th Carnival of Real Estate, which can hence forth be referred to as The 2007 Dundie Awards. Not sure of the context? Perhaps a short video will help:

Without further ado, on to the award that money can't buy.....unless you have $19.99 plus $9.50 shipping. Just don't tell your neighbor.

The Show Me The Money Award - Danilo Bogdanovic shares the Real Estate Agent 2.0 Report Card - What Works and What Doesn't. A great summary and honest commentary on what works and what doesn't.

The Fine Work Award - Sara tells a tale of a recent nightmare in For Sale By Owner: Why I Woke Up Screaming. A list of potential hazards for potential FSBO buyers.

The Spicy Curry Award - The Art Thailand Blog recounts one experience of buying and owning a condo in Thailand.

The Don't Go In There After Me Award - Cindy Lin gives some great advice as it pertains to the realm of home inspection. specifically how NOT to try and get into the industry.

The Whitest Sneakers Award - Craig Schiller takes this award with a very interesting discussion about the need for accountability through statistics for home stagers. Bonus points for being the very first submission this week.

The Grace Under Fire Award - Jonathan Dalton has some interesting thoughts on The truth about NAR and licensing.

The Hottest In The Office Award - Pat Kapowich provides a recap on a recent round table discussion of Real Estate and Mortgage Fraud.

Last but not least, the grand champion of them all:

The Busiest Beaver Award - Mike Mueller puts on his metaphor hat to explain some new accounting rules that will play a significant role in the coming days on Wall Street, and some of the firms to watch.

Thanks again for all of the submissions and have a safe and happy holiday!

The Week Ahead in the Capital Markets

2007-11-13T23:21:00-06:00

The Week Ahead in the Capital Markets - November 13, 2007

“Your eyes do not deceive you. Treasury yields plummeted last week, and mortgage rates barely budged. In fact, mortgage rates rose 0.30% relative to duration-equivalent Treasuries. The spread between mortgages and Treasuries eclipsed 2.00% for the first time in years. Back in 2002, mortgages traded 2.50% over the curve for a brief period. For much of 2004, 2005, and 2006 the spread was 1.25%.

It is not a coincidence that spreads are wide today like they were in 2002 and 2003. Then, as now, the Fed was in a rate cutting mode and there was great uncertainty as to the future of interest rates. When such uncertainty exists, buyers of mortgages demand a greater relative yield to compensate for prepayment risk. Hence the wide mortgage-to-Treasury spreads.

So what will it take to narrow the spread? Some certainty about interest rates. If the Fed stops cutting rates sometime next year, and signals that they intend to leave rates alone for some time, it is very likely that mortgage-to-Treasury spreads will come down.

In the meantime, short-term rates are very volatile. Fed funds futures pushed to levels not seen in some time – August 2008 futures traded down to 3.67% on fears of economic slowdown. There is only a 50% chance for a rate cut in December, but after that, significant cuts are built in. Also the yield curve steepened +0.80%, a level not seen since early 2005. Recall that the difference between two-year and ten-year Treasuries was -0.10% only a year ago.

As for credit spreads, core jumbo prices held in last week, although we saw several price hits worsened for high-CLTV loans. Fannie Mae also announced price adjustments that will affect core agency loans in the high-LTV, low-FICO bands. The move by Fannie Mae was significant – It was the first such credit adjustment to their core products in many, many years.”

The writers are on strike. ... They are calling this the toughest time for comedy writing since those three weeks back in the '90s when Bill Clinton stopped dating. – (Jay Leno)

Fun Friday

2007-11-09T07:59:38-06:00

Last Sunday's Mister Boffo:

Prisoners of Debt

2007-11-05T15:56:47-06:00

BusinessWeek has a great article regarding collection and charge off accounts post-bankruptcy (thanks to Barry Ritholtz at The Big Picture for bringing it to my attention).

In a financial version of Night of the Living Dead, debts forgiven by bankruptcy courts are springing back to life to haunt consumers. Fueling these miniature horror stories is an unlikely market in which seemingly extinguished debts are avidly bought and sold.

The case of Van Rathavongsa illustrates how canceled debts regain vitality. The Raleigh (N.C.) factory worker pulled himself out from beneath a mountain of bills by means of a bankruptcy proceeding that wrapped up in 2002. One of the debts the judge canceled, or "discharged," was $9,523 Rathavongsa owed to Capital One Financial (COF), the big credit-card company. But Capital One continued to report the factory worker's discharged debt to credit bureaus as a live balance, according to documents filed in U.S. Bankruptcy Court in Raleigh...To obtain the home loan, Rathavongsa eventually did what many consumers in this situation do. He gave in and paid Capital One $9,523 he no longer legally owed.

The full article can be found here:

Prisoners of Debt

It's actually quite scary to think about some of the tactics that these institutions are utilizing. If you are in a similar situation and have some questions please feel free to contact me. I am not an attorney but have had a fair amount of experience working with clients to improve their credit. If it's beyond my area of expertise I will happily refer you to a qualified attorney.

The Week Ahead in the Capital Markets

2007-10-29T09:39:00-05:00

The Week Ahead in the Capital Markets - October 29, 2007

A Halloween rate cut in is the bag. The parade of bad news in the housing market will likely drive rates lower for the foreseeable future. This in spite of the dollar hitting new lows against major currencies and gold, and crude oil topping $90 a barrel. Odds are 100% for a 0.25% cut this week, and 100% for another 0.25% cut in December.

“It felt like we were waiting for a monthly employment report on Friday, only we were waiting for Countrywide’s (CFC) earnings report. CFC reported less loss than expected, which is good for Countrywide and good for the mortgage industry. Everybody was nervous when CFC’s stock price nearly dropped below $12; it rallied all the way back to $17 in a relief rally on Friday. CFC’s balance sheet improved on the liability side as well. Barron’s reports that the yield on CMC’s debt fell 0.40%, and the cost of CFC credit default swaps – essentially an insurance policy against Countrywide going out of business – dropped 1.00%. All of this good price action is predicated on CFC weathering the storm. As for the rest of the credit spectrum, ABX indices hit new lows last week, but jumbo core spreads hung in at respectable levels.”

While nearly half of consumers surveyed said they could not accurately explain what a sub-prime mortgage is, 75% of consumers say banks and mortgage lenders and brokers are “extremely responsible” or “very responsible” for the sub-prime mortgage crisis. 60% assign that level of blame to the real estate industry and 58% do so for borrowers who took out loans they could not afford, reports American Banker. The survey also found that Americans ranked the sub-prime crisis above global warming and the federal deficit among their most pressing concerns — though it ranked below terrorism, health care, the war in Iraq, the overall economy, and illegal immigration. Seventy-six percent of those surveyed said the sub-prime crisis was “just as serious” as or “more serious” than the dot-com crash of 2000.

From 2004 to 2006, 43.6 million mortgages were issued across the county, 10.3 million of which were sub-prime. In the prime mortgage space, about 10 million mortgages were originated each year, roughly half of which were refinance transactions. Bear Stearns predicts that the tightening in mortgage credit will extract between 1.4 to 1.5 million purchase borrowers. This implies a decline in purchase volume from a peak of 6.2 million units in 2005 to slightly under 4 million units by early 2008.

Congratulations to Al Gore for winning the Nobel Peace Prize. I thought this was sad: Al had the Nobel Peace Prize for less than a week when O.J. broke in and stole it. – (David Letterman)

The Week Ahead in the Capital Markets

2007-10-22T13:49:00-05:00

The Week Ahead in the Capital Markets - October 22, 2007

Just make it to May (the date of the next national secondary conference). That was the mantra of attendees at the national mortgage conference in Boston last week, as they bemoaned the terrible condition of today’s mortgage market. The upshot of the conference was that while volume is slow, the mortgage business remains a tale of two originator types: those that can effectively compete with agency products, and those that cannot. The spread markets (jumbo core, alt-A, sub-prime) have recovered somewhat since the Fed rate cut, but securitization volume is pitifully weak, and originators of spread products are still looking for answers.

“Jumbo loan prices are holding steady. Two weeks ago, spreads moved tighter and they remain at decent levels, equal to pre-collapse levels of the summer. A few jumbo securities have traded, and liquidity is creeping back. The same cannot be said for sub-prime loans. The BBB- ABX index set a new low last week, in spite of hopes for a bail-out from the master conduit proposed by the Treasury. Regarding conforming products, mortgage rates did not fall as far as Treasury yields last week. The prospect of greater volatility pushed mortgage rates 0.15% higher relative to Treasuries. The yield curve, as measured by the difference between two- and ten-year Treasuries, also steepened by 0.15%. Financial companies that borrow short and lend long cheered the news.”

Odds for a Halloween rate cut soared. According to Fed-funds futures, a 0.25% cut next week is almost certain, and futures are predicting sub-4.00% Fed funds for next summer.

Given the severity of the bond market collapse, the stock market has been surprisingly quiet. Sure the Dow took 126 days to move from 12,000 to 13,000, and just 58 days to zoom to 14,000. And then it was hit hard late last week. But a recent blog put today’s volatility in perspective: “Friday’s 366-point decline rates as only the 626th largest in since the start of the Dow in 1896. Put in another way, we have seen drops of this magnitude or worse on 2% of all trading days over the past 111 years.” Tread carefully because stocks could post some historically volatile numbers in the days and weeks ahead.

According to a new report, security screeners at our nation's airports -- this is scary -- failed to find fake bombs hidden on undercover agents 60% of the time. ... President Bush said today, “Well, who cares about fake bombs?” – (Jay Leno)

The Week Ahead in the Capital Markets

2007-10-08T10:12:00-05:00

The Week Ahead in the Capital Markets - October 8, 2007

“Jumbo loan prices – of both the adjustable- and fixed-rate varieties – had a banner week. Spreads, while not back to pre-collapse levels, are trading at levels that might even be called respectable. Our sources tell us that while lower credit tranches are not yet trading well, the AAA pieces are as well-received as they have been in months. Rate sheets came back in stair steps, with Wells posting strong fixed-rate bids early in the week, and CitiMortgage and Chase posting very strong ARM levels late in the week and today. While spread markets are still volatile, we are getting more optimistic by the day. Corporate bonds, junk bonds, and LIBOR swap spreads are all moving tighter because liquidity has returned to the financial markets. Banks are lending, the commercial paper market has stopped its collapse, and LIBOR has returned to approximately 0.50% over Treasuries.”

Even the employment markets seem to be recovering. “Was it all a dream?” asks Barron’s in reference to August’s terrible jobs report. September’s report was right on the money (+110,000 jobs) and was full of upwards revisions that made the August report a whole lot better (+89,000 jobs instead of a loss of 4,000). Friday’s report made trading interesting – the ten-year Treasury fell 100bps and has returned to where it was prior to the Fed rate cut.

The odds for another rate cut on Halloween dropped to about 50/50, and plunged for any cuts beyond that. The last three times the Fed initiated a new easing cycle, ten year bond yields dropped 20 basis points or more in the next five days. This time they rose by 20 basis points, which didn’t help mortgage rates a bit.

Are our dreams of lower rates turning in to nightmares? Bill Gross and John Mauldin don’t think so. They are both predicting that the Fed will cut rates to 3.75% before the housing mess is done. At the moment, however, the bond market is clearly worried about inflation. “The market should start worrying about something else,” said John Mauldin. “Inflation is not a problem in a recession, and certainly not in one caused by the bursting of the largest housing bubble in US history. Be definition, those are deflationary events. If we have a simple slowdown I think rates drop to 4% or less. If we see a recession, short term rates will drop below 3%.”

Here's good news: George W. Bush says that he is committed to fighting global warming. Yeah, well, he nipped that in the bud, didn't he? – (David Letterman)

The Week Ahead in the Capital Markets

2007-10-01T13:38:39-05:00

The Week Ahead in the Capital Markets - October 1, 2007

Jumbo loan prices have improved dramatically from their lows. Most notably in recent days, prices improved at Wells Fargo. Other major jumbo investors also have moved pricing tighter. Relative to conforming pricing, the average jumbo price has improved a full point from the worst levels. Several investors improved their pricing by two points from the worst. Spread markets are still too volatile to sound the ‘all clear’ bell, but recent market action bodes well.

Jumbo prices are but one of the markets showing improvement. Citigroup said that certain homebuilders – D.R. Horton and Lennar – are a “buy.” The Dow is trading above 14,000. Corporate bond spreads have moved tighter, and investors are upping allocations to corporates. The volume of commercial paper, on the other hand, continues to shrink. Asset-backed commercial paper issuance remains in free-fall. The decline (or increase) in the amount of CP outstanding is a key, forward-looking economic indicator. Fortunately, energized by the Fed’s recent cuts to the discount rate, bank lending is replacing the lost CP liquidity.

“The bank was saved but the money was ruined.” So says William Gouge (1796-1863), one of the best political economists of the American 19th century. He spoke of the panic of 1819, but his words are being repeated by critics of the Fed’s rate cut. The core argument is that as the Fed works overtime to save banks from their bad mortgage investments, they are risking dollar-based inflation and a loss of confidence. In the worst case, a collapse of the dollar would result, leading to inflation and high interest rates.

The outcome depends on whether or not the U.S. economy heads in to recession, and its broader effect on the global economy. Which leads me to the hemline theory, as recently reported in Time magazine: The length of hemlines predicts how the U.S. stock market will do – the shorter the hemlines, the better the performance. The hemline theory’s record is hit-and-miss. Hemlines were short in the Roaring Twenties and got longer just prior to the 1929 stock market crash. Mini skirts in the 1960s were credited with, among other things, a stock market rally. Short hemlines accompanied a great market in 2006. Longer hemlines are showing up in fashions for spring 2008, perhaps predicting economic woes ahead.

As you know, the Iranian president said a lot of stupid things yesterday. My favorite is when he said there are no homosexuals in Iran. Many Americans disputed his claim. In fact, Idaho Senator Larry Craig volunteered to go over there on a fact-finding mission. – (Jay Leno)

The market will close early on Friday.

What Did You Do With Your Summer Break?

2007-09-27T12:56:00-05:00

It's a day early for Fun Friday but I couldn't let today go by without mentioning the fact that The Office season premier is on tonight. Here is a web only clip that NBC posted on YouTube to catch viewers up on what the characters did with their summer. I hope you enjoy it!

The Week Ahead in the Capital Markets

2007-09-24T12:51:00-05:00

The Week Ahead in the Capital Markets - September 24, 2007

“The dust is still settling after the Fed used ‘an ax instead of a scalpel to cut rates,’ as Barron’s put it. Mortgages have been volatile. Tuesday, prices rose 0.50%; Thursday, prices fell 0.75%. The yield curve steepened. The 10-year Treasury yield rose 0.16% more than the 2-year yield. Credit spreads – especially those affecting jumbo core loans – have moved in ever so slightly. For everything other than cream-puff loans, jumbo core yields remain at very high levels relative to agencies. Mortgage-to-Treasury spreads narrowed. Mortgages currently yield 1.65% more than Treasuries, about 0.10% less than pre-Fed levels. Demand for mortgages is up; banks usually increase their purchases of mortgages when the yield curve is steep.”

The market’s early opinion is that the Fed cut is good for economic growth (stocks soared worldwide) and bad for inflation. Commodities moved to levels not seen in decades. The U.S. dollar famously reached parity with Canada’s loonie, and sank to fresh lows against the euro. Oil and gold soared to new highs.

Bill Gross thinks the Fed will ultimately take rates down to 3.75%, as the housing slump slows the economy. Whether the Fed cuts rates again, however, will rest on the economy’s performance in the months ahead. The futures market predicts a 0.25% cut before year end, and another 0.25% cut in early 2008. Opinions vary. Bear Stearns believes the Fed will not cut again, and will be forced to raise rates in 2008 as inflation pressures mount.

The lessons of history are mixed. Only twice in the last 20 years has the Fed started a rate cutting cycle with a half-point reduction, as noted by Bill Gross. Both times, the economy fell into recession and more rate cuts resulted. The last two times the Fed acted in response to financial market chaos, however, they cut rates only to reverse course and raise rates shortly thereafter. Neither the 1987 stock market crash nor the 1998 debt crisis had as much affect on the economy as anticipated, and the Fed eventually raised rates.

A University of Florida student was subdued with a taser after asking John Kerry about the 2004 election. It was the first time anyone’s been electrified at a John Kerry speech. – (Jay Leno)

The Week Ahead in the Capital Markets

2007-09-17T12:44:00-05:00

The Week Ahead in the Capital Markets - September 17, 2007

It will be a “long slog” for Northern Rock if they wish to remain independent, analysts say. Proving that the real estate mess has gone global, the Bank of England bailed out Northern Rock, England’s fourth-largest mortgage company. Northern Rock required emergency financing because it relies on the capital markets rather than deposits for 73% of its financing, reports Bloomberg. Northern Rock’s stock price is down 63% this year, and its “high cost of wholesale financing” is expected to continue for the foreseeable future. Sound familiar?

Fears of a global slowdown argue for a 0.50% Fed rate cut this week; last week’s modest turnaround in the credit markets argues for 0.25%. There is some debate over whether the consensus is calling for 25 or 50, but Barron’s reports a 58% probability of a 0.50% cut, versus a 42% probability of a 0.25% cut. After this Tuesday, the Fed’s next meeting will be on Halloween.

On the eve of the Fed meeting, signs of inflation are rearing their ugly heads: gold is trading above $700 per ounce, oil is above $80 per barrel, and the dollar is making new lows. The credit markets are also recovering slightly: the spread between LIBOR and Treasury yields is moderating, the mortgage-to-Treasury yield spread is stable at 1.75%, and commercial paper rates are falling from extreme highs.

The change in the amount of commercial paper outstanding is a one of the most important forward-looking measures for the debt markets. And it is not looking good. Liquidity is draining out of the system, and the economy will begin to struggle. Commercial paper outstanding – including asset-backed commercial paper that sometimes is backed by sub-prime loans – fell by 13% last month alone. As reported in Bill Coppedge’s news items: During the 2001 downturn, commercial paper peaked in November 2000 and slid through to December 2003. The volume fell by 22%, but it took three years to do so.

In his big Iraq report, General Petraeus said the troops can start coming home next summer. ... I believe his exact words were, “And then it's Hillary's mess.” – (David Letterman)

The Week Ahead in the Capital Markets

2007-09-10T14:05:22-05:00

The Week Ahead in the Capital Markets - September 10, 2007

Negative jobs reports have predicted twelve of the last fourteen recessions. Nevertheless, stock and bond markets reacted quickly to Friday’s report, and a series of Fed rate cuts seems to be in the bag. The question amongst traders is not whether the Fed cuts rates on September 18th, but whether they cut by 0.25% or 0.50%. Rumors even circulated about a mid-day rate cut on Friday. Implying a cumulative 1.25% of upcoming rate cuts, May fed funds futures closed at nearly 4.00%, down almost 0.50% in two weeks. Several Fed officials will speak this week, and the market will listen closely.

Treasury yields plummeted. The spread on TIPS (the market’s best guess on inflation) is hovering just above 2%. And Fed funds are at 5.25%. “The market is screaming for a rate cut,” said John Mauldin. The ten-year yield fell to a level not seen since January 2006, and the two-year fell all the way back to September 2005 territory. Breaking their pattern of the past few months – where mortgage yields seemed to be stuck in place – mortgage yields fell in tandem with Treasuries. The mortgage-to-Treasury yield spread held steady at 1.74%, and notional yields fell. In other markets, the dollar dropped sharply, and gold rallied to $700 an ounce.

The jobs report hasn’t been negative since 2003. The weakness was broad based and payrolls for both June and July were revised down, from 92,000 to 68,000 in July and from 126,000 to 69,000 in June. That is an average of less than 46,000 a month for the last three months. The economy needs to create 150,000 jobs a month just to tread water. Economists from Bear to Goldman to Merrill revised global growth projections lower, and most think the U.S. economy is careening towards recession in 2008. The extent of the economic downturn is uncertain. The housing and credit problems will take their toll, but fortunately, corporate balance sheets are strong and stocks are trading at a modest 15 times earnings.

Mortgage bankers are gloomy from the succession of body blows the industry has taken, but most cheered the news of lower rates. Refinance activity is sure to pick up, but there are challenges ahead. Bankers don’t just need lower rates, they need liquidity from investors and warehouse lenders, tighter spreads on jumbo product, and stable home prices. All of which remain in short supply. Jumbo core spreads are still shockingly wide, although they seemed to have reached a bottom. There are a few whole loan buyers in the market, but jumbo securitization is non-existent.

Did you know that when President Bush is in Australia, his approval rating goes down the drain counter-clockwise… -- (Jay Leno)

The Week Ahead in the Capital Markets

2007-08-27T08:05:23-05:00

The Week Ahead in the Capital Markets - August 27, 2007

The warehouse lenders took center stage as the mortgage drama took another grim turn. Warehouse lenders (they lend money to mortgage bankers to make their loans) clamped down on their lending policies last week. One said it needed 20% down on any loan that wasn’t headed for a government agency. Another said that it would fund “up to a price of 0%” on any stated income product. Yet another said it was shutting down any mortgage banker holding unsaleable loans. Mortgage bankers scrambled to find financing for their loans, and bank-owned mortgage lenders gained yet another competitive advantage.

It began with sub-prime loans going bad, and then really bad. In March, the problem leapt up the credit curve to Alt-A loans. Then corporate credits, the yen carry trade, and AAA CDOs blew out. The AAA jumbo market fell apart, and we worried that the mortgage industry’s largest player was going under. All along the way, mortgage bankers, REITs, and mortgage investors imploded.

So where and when does it all end? Foreclosure rates are double last year’s pace. Delinquent loans are piling up faster than they have since 1990. Real estate folks by the thousands are losing their jobs. And nearly $1 trillion of adjustable mortgages rates are set to rise in the next year, making all of the above that much worse. A recession would seem almost inevitable, and will certainly occur in the opinions of Angelo Mozilo and many others.

Albert Edwards at Dresdner Kleinwort puts the odds of a recession at 40%, and thinks Fed funds and bond yields might fall below their previous cyclical lows of 1% and 3.1%, respectively (as reported by Barron’s). Stocks are hanging in for the moment, but Edwards thinks they could fall by historic proportions. “Strong and steady growth rates in the U.S. are a Ponzi-like mirage built on an unsustainable mountain of debt." A 0.25% Fed rate cut is already baked in to the market for the September 18th meeting.

Elizabeth Edwards said the problem with John Edwards' fundraising -- you know, compared to the other candidates -- is she can't make him black and she can't make him a woman. That's the same problem Michael Jackson's people have. -- (Jay Leno)

Liquidity and It's Importance in the Bond Market

2007-08-22T15:45:30-05:00

This is an article I ran across that simplified the explanation of the function and operation of the secondary mortgage market. It was sent out from an account executive and apparently the information is attributable to the VP of Mortgage Production for a local bank (though I can't find the person's name or company). Overall it is a simple and concise explanation.

In years past a borrower would visit their local Savings & Loan to obtain a mortgage. The Loan Officer at the bank would approve the mortgage and fund it with cash reserves from the vault. This system worked well until the bank ran out of money to lend. Borrowers came to the S&L looking for a loan and were told to come back when a current mortgage was paid off. What the bank needed was a way to sell the loans it made, freeing up the capital to lend to new borrowers. This way they could lend the “same” money over and over, earning an income from servicing the loans and assisting the community by offering a near limitless pool of money.

To address this issue, FNMA and GNMA were established. The goal was to provide cheap mortgage money to prospective homeowners and a high quality bond for the investment community. The bond or Mortgage-Backed Security (MBS) takes mortgages with similar risk characteristics and pools them together. Investors in the MBSs know ahead of time the return they are going to receive, much like a Certificate of Deposit. To ensure the performance of the bond, each mortgage is underwritten to specific guidelines. By ensuring the borrower is both capable (Verification of Employment), willing to repay (credit report) the debt, has the cash to close (Verification of Deposit), and the value is in the property (appraisal), the loans and thus the bond will perform as expected.

During the recent real estate boom underwriting guidelines were relaxed giving way to a whole new menu of products such as the 100% N/O/O (Non-Owner Occupied, or a fancy way of saying an investment property) with credit scores below 600. In addition, to streamline the influx of applications, income and asset verification took a back seat to a borrower with strong credit. With housing prices rising rapidly, the basis for the mortgage, the property, could be sold to cover the note and foreclosure costs if this occurred. This cycle worked well until the price of houses moderated in 2006.

Once the housing market began to cool and prices moderated, foreclosed homes were being sold for less than the note. To add insult to injury, the loans underwritten to the looser guidelines are not performing as hoped. With the value of the collateral in question (falling home prices) and the future performance of the borrowers unknown, investors’ appetites for this risk has waned. To attract investors in this environment, rates had to increase substantially.

Loans sold to GNMA or FNMA remain largely untouched in the recent credit rout because the investment qualities of the loans are well known. The foreclosure and delinquency rates are well within acceptable standards lending support to these products as their interest rates have fallen in the recent weeks.

The recent rapid rise in rates not directly tied to FNMA/GNMA is an example of the pendulum swinging too wide. The fact remains that a qualified borrower is a good investment from a bondholder perspective. In a typical interest rate market, jumbo loans (loans in excess of the conforming limit) with proper documentation carry a yield about 1/4 higher than similar conforming products. Sanity will eventually return to the markets and non-conforming pricing will come in line with their risk characteristics. The depth and breadth of the current subprime issue will determine when that change occurs.

As always, I am here to help educate and inform you throughout this turbulent time. If I can be of assistance in any manner, please don't hesitate to contact me.

The Week Ahead in the Capital Markets

2007-08-20T11:24:02-05:00

The Week Ahead in the Capital Markets - August 20, 2007

The mortgage problem has spread and Countrywide is in trouble. So the Fed is on the move. As a lender of last resort, The Fed just cut the discount rate (the rate at which banks borrower from the Fed through the discount window). In a highly unusual move, the Fed also said banks could borrow for up to 30 days and then renew their loans. The last time the Fed let banks borrow for more than a day was in 1999 for fear of Y2K computer problems. The Fed said, “These changes are designed to provide depositories with greater assurance about the cost and availability of funding.” Changes will remain in place until “market liquidity has improved materially.”

All of a sudden, the fed-funds futures market priced in 1.00% of near-term cuts (Fed funds is the rate at which banks lend balances held at the Fed to one another). Earlier this summer, there were no expectations of rate cuts at all. The world has changed. As Keynes said, “When the facts change, I change my position. What do you do, sir?” According to futures, there is 100% likelihood that Fed funds will be at or below 4.25% by May, and one-month bills currently yield less than 3.00%. ARMs anyone?

The mortgage industry has a black swan problem (a phrase coined by Nassim Taleb). You can have a database with 4,000 white swans. History and the data tell you that all swans are white. But the absence of a black swan doesn’t mean there isn’t one, and risk models fail if one shows up. The likelihood of credit spreads widening to the degree that they have – and on some AAA credits no less – is statistically extremely unlikely, something on the order of one to the power of minus 500! But it did happen, even though the historical data said it was improbable.

Countrywide is the latest victim of the black swan. In a shocking turn of events, mortgage bankers spent last week worrying about Countrywide going away. Countrywide’s business units reach far and wide. Countrywide made $245 billion in home loans in the first half of the year, 17.4% of the nationwide total. Warehouse lines, broker and correspondent loan purchases, securities trading, and an alphabet soup of ancillary services have made Countrywide a force to be reckoned with.

Our industry’s market share leader got hit hard. Already down more than 50% from a price of $45 earlier this year, Countrywide’s stock price sank to a low of almost $15, and recovered by week’s end to $21. That upshot is that while Countrywide’s problems are mostly about a lack of liquidity, a Banc of America analyst thinks they have enough borrowing capacity to survive. He says that the current stock price “fairly balances” the unlikely outcome of a liquidity-induced asset sale and the more likely prospect of an operating, “less profitable” company going forward. We wish them the best.

President Bush did not call Barry Bonds immediately after he broke Hank Aaron’s homerun record. But Bush decided to make the call. Bush said, “I realized I had a rare opportunity to talk to the only guy in the country who is less popular than I am.” – (Conan O’Brien)

How Are We Paying Off Our Subprime Mortgages?

2007-08-17T09:00:00-05:00

Our friends over at The Onion have conducted a survey and here are the results:

If none of these options are viable for you, please contact me for some legitimate financing options.

Have a great weekend!

Mortgage Market Update

2007-08-16T17:34:14-05:00

I apologize for the lack of posts this week, but my time has been significantly occupied advising clients and conducting planning sessions this week. In addition I have spent a tremendous amount of time reading and educating myself as to the changes in the mortgage market. We are seeing significant, historical events unfold in the mortgage industry on almost a daily basis. Rather than recap much of what has been said, I'm providing some of the more interesting and noteworthy articles I've run across during the past week.

First Magnus Halts Loans - First Magnus was a very large wholesale lender

Aegis Mortgage Files for Chapter 11 - At one time Aegis was one of the top 30 lenders in the nation

HomeBanc Files for Bankruptcy - A large lender based in Atlanta - and in a related note.....

Creditors Now Awaiting Move by HomeBanc - HomeBanc is also bouncing checks

US Fed Pumps $38Bln into Economy - Largest Since 9/11

Thornberg Cites Financing Woes but Rules Out Chapter 11

Countrywide borrows $11.5Bln to pay the bills

Countrywide Falls; Merrill Cites Bankruptcy Prospect

Accredited Sues Lone Star Seeking Closure Of $400 Mln Takeover - This is the rough equivalent of agreeing to buy a 'classic' European car only to discover during inspection it's a Yugo.

Very Important - Guideline Changes Effective August 8th, 2007

2007-08-10T09:50:41-05:00

Perhaps we'll be ok if everyone can maintain a sense of humor. This was just sent to me from our Countrywide rep:

Guidelines Changes Effective August 8th

All borrowers must have one blue eye and one brown eye to qualify
LTV >65% SIVA (Stated Income, Verified Asset) requires a credit score of 849
For all LTVs greater than 65%, 360 months of payment reserves required
Borrowers must have no bankruptcies in their family history going back three generations
A minimum of 25 years self-employment required for all NIV (No Income Verification) at same location
Minimum credit for subprime loans raised to 720
All non-arm's length transaction borrowers (mortgage, real estate, and family members) will be required to provide full documentation, subject to criminal background checks, wiretapping, strip-searches, and a minimum 12 hours of interrogation by the Department of Homeland Security.

Please note that these changes will go into effect in five minutes. Any locked loans must fund by noon tomorrow.

For those of you not in the mortgage industry, please realize that we have been receiving emails of this sort with legitimate guideline changes on a daily basis from many lenders. You may not have a great appreciation of it but surely all mortgage professionals will.

Have a great weekend!

The Truth about Appraisals

2007-08-09T20:40:36-05:00

The following article is one I have frequently given to clients when appraisal issues have arisen. Hopefully it will help you understand a little more about the process and what goes into an appraisal.

Many consumers are often frustrated when they have a home appraised. Often, they feel that their home is worth more than the appraised value. In many cases they are right! This does not change the fact that real estate appraisers must adhere to very specific rules and guidelines that are dictated by the lender. A few years ago, lenders added a requirement to appraisal guidelines, stating that the intended use of the appraisal must be indicated in each appraisal report. This is simply because appraisals can be used for different purposes, each having different values and rules.

In determining value for the purpose of a finance transaction, appraisers must follow guidelines set by the lenders, which in many cases results in a slightly more conservative estimated value. Everything that an appraiser adjusts for positive or negative must be bracketed and supported by the comparable sales. For example, if a home is purchased for $100,000 and the owners choose to add a pool at a cost of $30,000, the value of the home does not automatically increase to $130,000. The appraiser must determine through a paired sales analysis what the market will support for a pool. If, in the same marketplace, a comparable home without a pool sold for $100,000 and a comparable home with a pool sold for $115,000, then the appraiser can only support a $15,000 adjustment. This is the case with any features that an appraiser can adjust for, not just a swimming pool. There is no set figure for any feature like a view, pool, spa, square footage, bathroom upgrades, etc it must always be bracketed.

On homes two to three years old or newer, upgrades typically can be recovered in an appraised value at actual cost, as the only way for new homes to have these upgrades is to pay actual cost. This is typically reflected in higher selling prices. However, when dealing with older homes, upgrades usually do not recapture their full cost for the same reasons indicated in our previous example dealing with the addition of a pool. Here is an extreme example: If a 40 year old home in average-to-good condition is purchased for $100,000 and the buyers choose to tear down the existing dwelling and build a new house at a cost of $100,000, the value is not automatically $200,000. The reason for this is because the original structure had value. Unless the home is in very poor condition, the sales price reflects value for the subject improvements. Therefore in this case, if the value of the original dwelling was $50,000 with the remaining $50,000 being land value, the new estimated value would be closer to $150,000, meaning that when the existing structure was torn down, that constituted a loss of $50,000 in value. The same applies to a kitchen or bathroom remodel, in that the original kitchen or bathroom had value in its original condition. This is why the cost of upgrades or remodeling of older homes can rarely be fully recaptured. Again, there is no set figure only what the market will support for an upgrade or remodeled home vs. one that is not.

State and lender guidelines require appraisers to base value on closed and verified comparable sales. Although property values are increasing in most areas of the country, typically lenders will not allow time adjustments to be made on comparables that sold within the past 6 months. In regards to pending sales and listings used as comparables in a report, some lenders actually require appraisers to use both a pending sale and a listing. This is not for the purpose of supporting a higher value in the lenders eyes; it is only to show that current market activities still support the closed comparable sales used. When using pending sales or listings as comparables, lenders want to see an adjustment made for possible negotiations. (Yes, even though many homes over the past couple of years have sold above their list prices!) Typical adjustments are usually between 5% and 10% off of the list price. This guideline is a safeguard to prevent appraisers from appraising too high. Furthermore, guidelines also indicate that appraisers can only base their opinion of value on sales that have closed escrow, and the pending sales and listings can only be used to support the closed sales.

If the appraisal were completed for a reason other than a mortgage finance transaction such as to determine a reasonable list price, you would likely see a higher estimated value. As in this case, listing and pending sales would be the primary support for the value estimate. When property values in a given marketplace are in the process of a drastic increase, this allows an appraiser to value property in real time based upon current pending sales or listings rather than sales that, although they may have closed within the past three months, have actually gone into escrow four to six months prior.

It is also for this reason that, when appraising a home that has just sold within the past three or four months, a lender will not accept an appraisal at a significantly higher value than the previous purchase price based upon the passage of time alone, unless documentation can be provided that indicates the property sold below market value at the time it was originally purchased. The only way to show an increase in value is to provide documentation that supports upgrades or remodeling completed by the current owners since the last sale transaction took place. For example, if a buyer purchases a home in November of 2002 for $600,000 and the new owners have added $55,000 in upgrades, given the fact that it is a new home, the appraiser will likely be able to get full value for the $55,000 in upgrades. If the appraisal is documented properly, the appraisal on the home is likely to be $655,000.

Although there is nothing in writing, appraisers are typically given 5% margin of error by lenders. Any more than that and the value will most definitely be cut by one of the lenders appraisal review staff personnel. Therefore, an appraiser can fudge a couple of percent. While the reviewer will know when an appraiser is pushing its value, if it is within that 5% range, they will most often let it slide. If an appraiser pushes beyond the 5%, lets say to 6%, 7% or 8% above and beyond what it is truly worth based upon comparable sales, the reviewer in charge of the file will take it all away and cut the value by the full 7%. Keep in mind that every single lender in todays mortgage marketplace has a review department. Therefore, given the example just mentioned, it would not be in the appraisers or the clients best interest to push the value too much. It could end up exposing the property evaluation to a severe appraisal review!

The Week Ahead in the Capital Markets

2007-08-06T20:06:26-05:00

Note: Sorry for the delayed posting - we had some technical difficulties at the home office today

The Week Ahead in the Capital Markets - August 6, 2007

“The market can remain illogical far longer than you or I can remain solvent,” Lord Keynes famously said.

Last week earned its place in history as the pricing for prime jumbo loans plummeted, and in the words of Mike Perry, Indymac’s CEO, “Right now, other than the GSEs and Ginnie Mae….the private secondary market is not functioning.”

Investors simply do not have the confidence that they or the rating agencies can predict loan performance with any accuracy. Therefore, private securities cannot meet investment criteria, and even AAA tranches are not trading. There is no demand for mortgage assets outside of Fannie Mae, Freddie Mac and Ginnie Mae. The ABX (mortgage credit) and LCDX (corporate credit) indices continued to set new lows. Most major lenders have either withdrawn or severely restricted their Alt-A offerings, jumbo note rates are headed above 8.00%, and premium pricing is nonexistent.

The historical magnitude of last week’s events, while not yet a feature in the popular press, brought comments from many corners. Bear Stearns’ CFO calls it the “worst bond market in 22 years.” That would take in such memorable episodes as the October 1987 crash, the 1994 mortgage-derivatives meltdown, the 1998 Long Term Capital Management debacle and the Enron and WorldCom collapses after the tech bubble burst, reports Barron’s. Paul Muolo in the National Mortgage News said, “I haven't seen a financial meltdown this swift since the S&L crisis of the mid-to-late 1980s.” Jim Cramer of Mad Money screamed that he hasn’t seen it this bad since “he was hit on a 5 bid for Citigroup in 1990.”

Confidence must be restored, and as the mortgage problem has shifted from credit to liquidity, the government has been called on to help. The central role of Fannie Mae and Freddie Mac is to provide liquidity to the markets. Look for the agencies to take action in the days ahead; they are currently formulating their plans. As for the Fed, credit is no longer easy, and the market is looking for a rate cut. Fed funds futures predict a 0.25% cut by October, another 0.25% by February, and a 50% chance of another 0.25% cut by next summer. The FOMC meets this week (statement due Tuesday 2:15pm EST), and so anything could happen.

Happy Birthday to Arnold Schwarzenegger. 60 years old. You can tell he’s getting up there. Remember when he used to say things like, ‘I’ll be back’? Now he says, ‘Ow, my back.’ (Jay Leno)

Your House

2007-08-03T09:00:00-05:00

This is one of those real estate centric emails that makes the rounds ever so often, and I thought it was worth sharing.

Your house as seen by...

Yourself...

Your buyer...

Your lender...

Your appraiser...

Your tax assessor...

Have a great weekend!

The Myth of the Equity Rich Home

2007-08-01T22:03:48-05:00

There are many misconceptions in the mortgage universe, but perhaps none are potentially as dangerous or as costly as this particular mistake. My clients are often caught off guard and I wanted to share this with a larger audience in the hope that it will help someone.

The title of this post captures the issue - the myth of the equity rich home. I have talked to numerous clients who's goal was to pay off their mortgage as fast as possible. (In and of itself, there is absolutely nothing wrong with this goal, though some strategies are significantly better than others.) Some were making one extra payment each year while others were doubling up their payment each month. Their logic was that if anything ever happened, they would have an extra cushion because they didn't owe much on their mortgage in comparison to the value of their home. This couldn't be further from the truth!

This assumption can trace it's roots back to the Depression era in our country. Once upon a time, almost all mortgages were callable. When the stock market crashed in 1929, there was a chain reaction of events that caused an eventual run on the banks (think George Bailey and the Bedford Falls Savings and Loan). The bank's only option to meet the demand of the withdrawals was to call in the mortgages they held. These were generally the same people making the withdrawals, and didn't have the money to pay. We all know how ugly things got as the rest of the Great Depression unfolded. Some of the people that were least affected by all of this were the people that owned their home free and clear.

Things are very different now. Mortgages are NOT callable. Also, your mortgage is most likely not with the bank down the street but rather with a mega-servicer. Many people aren't aware of the fact that frequently the mortgage servicer does not own the mortgage. (For an ultra-detailed behind the scene look at servicing, please see this site). This can cause some challenges in the event someone is late on their mortgage or falls into some type of hardship.

The job of a servicer is just that, to process payments and in the event of a non-payment, take the necessary steps. They have some authority to make arrangements depending on a person's individual situation, but often they just follow orders from the investor that actually owns the mortgage. If suitable arrangements can't be made, the next step is foreclosure.

This brings me to my point. The more equity you have in your property, the more likely the investor will foreclose on your home and foreclose quickly. Think about it from the investors standpoint - you have two loans that aren't performing. Loan #1 is for $250,000 and loan #2 is for $190,000. The difference? House #1 is worth $500,000 and house #2 is worth $200,000. The investor knows with virtual certainty that it will be made whole on house #1 if it forecloses. House #2 is a much bigger risk as there is a much greater chance of suffering a loss. Thus the investor will be much more likely to work out an arrangement (reduced interest rate, forbearance agreement, etc) in order to try to save the situation and avoid foreclosure.

I share this story frequently with clients not scare them (hopefully) but to get them to think about alternatives. One option I share frequently is the idea of paying off your mortgage on your own personal balance sheet. Instead of sending that extra payment to your mortgage servicer, send it to your financial planner. Besides the fact that your money is very likely to grow faster than the cost of your mortgage (over the long run), you have the security of having the funds under your control. If you ever have an issue, you have a large reserve to see you through the hardship instead of parked in your house where it can't help you.

In closing, I wanted to mention that much of what I share is a generalization. Each situation will be different and the information I share may not apply to you for a variety of reasons. Stereotyping is never good (unless you are trying to sell t-shirts for The Onion) and I want to make sure I don't throw everyone into the same bucket.

If you are facing a hardship please feel free to contact me. I am happy to help, even if it's just sharing some advice with you.

The Week Ahead in the Capital Markets

2007-07-30T12:06:19-05:00

We have a world class secondary market department and they are kind enough to send out weekly updates to us sales monkeys. I like posting it as it is both a great source of technical and anecdotal information. Please let me know your thoughts!

The Week Ahead in the Capital Markets - July 30, 2007

As Herb Stein famously put it, “If something can't go on forever, it won't.”

Some weeks ago, analysts wondered whether the sub-prime melt-down would remain “contained” to a small corner of the economy, or whether it would become a “contagion” and spread its virus widely. Most analysts predicted the former. They were wrong, and the sub-prime virus has spread.

We are witnessing the end of a multi-year period when credit of all kinds was very, very cheap. For some time now, the markets have been operating in what Niall Ferguson called the “paradox of diminishing risk in an apparently dangerous world.” That meant booming global stock markets, low volatility, and record-tight yield spreads between risk-free U.S. Treasuries and anything risky. The paradox came apart last week, and the price of credit gapped higher in almost every market:

Sub-prime paper (BBB) in the mortgage markets is trading at less than $.38 cents on the dollar.
The spread between fixed-rate mortgage and five-year Treasury yields soared to 1.66%, up from a low of 1.10% two months ago, and back to levels not seen since 2004. The Treasury yield fell almost 50 basis points, and mortgage rates haven’t come down at all.
Swap and TED (Treasury-to-Eurodollar) spreads, which are good indicators of global appetites for risk, jumped to levels not seen for any sustained period since 2002. Five-year swap rates are trading 0.70% above the curve, up from 0.40% a few months ago.
Credit-default swaps, derivatives linked to the corporate bank loan market, widened dramatically. The cost of insuring against default moved up from 1.00% in May to close at 3.70% on Friday.
The Yen-carry trade added to the problems. The Yen jumped 4% and those borrowing yen and lending dollars rushed for the exits, only to find the way out awfully crowded.

So here we are with a credit crisis, Treasury yields dropping in a flight to quality, and a huge question mark around whether or not the Fed will come to the rescue. Greenspan reacted swiftly to credit problems during his tenure; Bernanke’s reaction is uncertain. With all of the spread widening that has occurred, spreads are only back to long-term average levels, but the market thinks the Fed will cut rates. For the first time in many months, Fed funds futures closed with near certainty of a rate cut by December, and expectations for 4.75% funds by the summer of 2008.

President Bush had that colonoscopy over the weekend… It was long, but a successful procedure. They removed five polyps and ten Al Gore ballots. (David Letterman)

Carnival of Real Estate

2007-07-30T10:25:39-05:00

This weeks carnival has been posted by Gena Riede over at her blog, and I have been fortunate enough to have had one of my blog entries selected as a winner. She has a great Monopoly themed carnival and I would encourage you to check it out!

Look into the Minds of Madmen

2007-07-27T12:02:08-05:00

For the purposes of today, we are going to journey behind the curtain into the mortgage industry. As simple as it may seem, the mortgage industry is infinitely more complex than most people realize. There are many rules, regulations, and guidelines that we follow that are not an arbitrary set of circumstances that some wizard (pay no attention to that man behind the curtain) has created. Rather, they are the result of years and years worth of experience and statistical probabilities. At the heart of any guideline discussion the essential question is: (if you are the bank) Will this loan perform?

There is certainly some give and take in the application of many of the rules and guidelines, but in some instances there is very little flexibility to be had. One such situation with little flexibility is seller concessions. There are three things a seller may pay on behalf of a buyer - points, closing costs, and prepaid items. Nothing else. The seller is not able to give any concessions or credits directly to the buyer for repairs, allowances (paint, carpet, etc), or down payment assistance.

There are certain instances when legitimate repairs need to be made and banks have systems in place for that. In these situations, the money necessary is given to a neutral 3rd party (generally an attorney) to hold until the work is completed. Once the work is done, the bank will re-inspect to make sure the work has been completed and the funds will be released to the contractor. This is generally referred to as an escrow hold-back and the bank will allow it because the buyer never has direct access to the funds. It can be tough to negotiate a hold-back as many lenders often want 1.5 to 2X the repair amount held in escrow. They have been around the block and know that there can be cost overruns, and they don't want to be left holding the bag.

Along a similar note, there are certain loans that allow for the seller to provide the entire down payment for the buyer. These are relatively rare and are often limited to first time home buyers (FTHB) and government loan programs. Also, it is generally required that a non-profit 3rd party is involved in this situation as well. The actual details can be quite complex, but I will summarize things and say that it is essentially impossible to have the seller directly give the down payment to the buyer with one exception. That exception? A direct gift is allowed from direct family members (parents to children, sibling to sibling, etc). The amount of the gift varies from 3% to 20%, depending on the type of loan. Again, the details and tax consequences can be fairly complex, so please feel free to email me if you have specific questions.

This information sets the table for a recent discussion I had with a potential client. The client called me as she had a condo under agreement for $165K. She was planning on putting 5% down, and the seller (a developer) had agreed to give her $4000 towards closing. The developer did not particularly care what she used the funds for. Her total closing costs came to approximately $3000. I suggested that we use the additional $1000 towards buying down her interest rate. The client then informed me that her attorney and the developer told her that she could just use the excess funds towards her down payment and reduce the cash she needs to bring to closing. I explained to her that while there was absolutely nothing illegal or immoral with what she wanted to do, lending guidelines simply won't allow it.

This client had also been talking to another mortgage professional, and the other mortgage professional told her that it would be no problem to apply the excess funds in the manner she wished. As a result, the potential client has decided to work with the other mortgage professional. My hope is that this client will close uneventfully and under the terms she has been quoted. My fear is that someone in underwriting or the closing department will catch the excess while reviewing the HUD, and the additional $1000 credit will be disallowed.

Forgive me for such a long post, but I want to delve further into the logic as to why this is a problem for banks. Banks have certain assumptions. One prominent assumption is that people generally value money they have earned and saved more than money that is given to them. Generally speaking this tends to be true. Banks also know that the more money a person puts down on a property, the more likely the loan is to perform. If we assume everything else is equal (job history, income, credit, etc) there are significantly different risks for a bank depending on whether someone is putting 20%, 10%, 5%, 3%, or 0% down.

Banks compensate for the additional risk in the form of a higher interest rate. In the above scenario, the client is trying to qualify for an interest rate based on 5% down, but she is not truly putting 5% down. It is very close, but there is a significantly different risk in lending to someone with 5% down in comparison to someone putting less than 5% down. Also, it's a slippery slope. A thousand dollars is not much money in grand scheme of things, but what about $1500? $2000? It becomes difficult to draw a line as to what's acceptable and what is not.

As a result, lenders have decided to limit a seller to contributing to the three things I mentioned above (points, closing costs, and prepaid items). They also limit the amount that can be contributed (between 3% and 6% with the contribution not to exceed actual costs). I will follow up with this potential client after closing. I am never a big fan of advising what other companies can and can't do (who am I to know the inner-workings of another company?), but I do have some serious reservations about what this client is being offered (based on my guideline knowledge of FanneMae, FreddieMac, and the 50+ lenders we work with). Hopefully she we be very happy and I will find out who she closed with and make sure they are added to our approved lender list. If not, maybe I can work with her on her next transaction and show her the way things are supposed to be done.

Thanks for reading and have a great weekend!

18 Years in the Making...

2007-07-27T12:00:00-05:00

If you have owned a tv at anytime within the last 18 years, you most likely are aware of The Simpsons. This weekend marks the release of the first (and possibly last?) feature length movie featuring the unique people of Springfield. It amazes me that the people who produce the show are still able to come up with ideas after 18 season. Several websites had the total number of episodes at 400 exactly. That's a lot of couch gags. I have posted one of the many Simpsons trailers available as the movie opens today!

Edited Monday July 30th, 2007

In case you missed this past weekend's box office figures, The Simpsons movie made almost $72 million. That was more than the 2nd, 3rd, 4th, and 5th place movies made combined. That's a lot of Krusty Burgers.

The Week Ahead in the Capital Markets

2007-07-23T12:08:43-05:00

The Week Ahead in the Capital Markets - July 23, 2007

“It is a capital mistake to theorize before one has data. Insensibly one begins to twist facts to suit theories, instead of theories to suit facts. The temptation to form premature theories based upon insufficient data is the bane of our profession.” – Sherlock Holmes

The good news is that Treasury yields continue to grind lower. Yields have fallen 0.35% from their mid-May highs, and are back down to late-April levels. A bid has come in to the Treasury market from a flight to quality and from conflicting signals in grains and energies. The collapse of those two Bear Stearns hedge funds – to 9% and 0% of their values – looms over the market. James Cayne, chairman of Bear Stearns, alluded to the uncertainty in the credit markets when he blamed “unprecedented declines in the valuations of a number of highly rated (AA and AAA) securities” for much of the hedge funds’ problems. Rain in the Midwest sent grain prices tumbling, and eased some fears about food price inflation. Conversely, energy prices march ever higher, and threaten economic growth.

The bad news is that mortgage rates, even those of the agency variety, have not come down nearly as much as Treasuries. The spread between agency and Treasury yields has widened by 0.25% in recent weeks; MBS yields are roughly 1.45% above equivalent Treasuries, a level not seen since late 2005. Nevertheless, the confusion in the credit markets has skewed product mix even more towards Fannie, Freddie, and Ginnie. Their products can be originated profitably, but efficiency and skill are paramount.

The U.S. Senate held an all-night session, trying to get the votes needed to begin troop withdrawal from Iraq. They stayed in the Senate chamber all night long, with some of them sleeping on cots. In fact, Hillary stayed up so late, she actually saw Bill sneaking in. (Jay Leno)

Weekend Roundup

2007-07-23T11:22:45-05:00

A compilation of interesting articles I ran across...

IRS to rescue when circumstances are grim

Being a crime victim is usually no cause for celebration. But there is at least one consolation: The IRS may give you a tax break when you sell your home.

Never be a lender -- without safeguards

Variously known as "taking back a mortgage" or "holding the paper," private financing is often heralded as the easiest and fastest way to sell a house, especially in a slow market.

It's All in the Extras: High-End Properties Reach for New Heights

These days, the can-you-top-this amenities include chic screening rooms, covered dog runs, golf simulators where you can practice your swing in front of a screen, wine cellars, boccie courts, rooftop beaches with sand and hammocks, and an "art concierge" to dispense expert advice on what to hang on your walls.

Drop anchor, you're home

With housing prices high, living on a boat is gaining popularity among ocean lovers.

Firefighters Tear Apart Wrong House

The Braintree Fire Department is investigating how a firefighter training exercise ended up tearing apart the wrong house.

What you get for...$500,000

Website Changes

2007-07-19T22:23:44-05:00

I recognize it has been a relatively slow posting week. I am in the process of migrating my other website over to my blog here. Typepad is a wonderful format - I can essentially archive my website on a separate blog and link it here. It is primarily a static website with a lot of content that will complement what I am doing here, and I thought it made sense to combine the two efforts.

Projects like this never go as smoothly as you would like, but I am hoping to wrap things up over the weekend. Thanks for your patience in the mean time!

Rate Shopping?

2007-07-19T22:08:12-05:00

Here is an article I often distribute to potential clients that are rate shopping. I don't deserve credit - save the applause for Sue Woodard of The Mortgage Market Guide. The information contained is timeless, and I thought it was worth sharing.

SHOPPING AROUND?

HERE’S THE INSIDE SCOOP ON HOW TO DO IT RIGHT!

First: make sure you are working with an experienced, professional loan officer. The largest financial transaction of your life is far too important to place into the hands of someone who is not capable of advising you properly and troubleshooting the issues that may arise along the way. But how can you tell?

Here are FOUR SIMPLE QUESTIONS YOUR LENDER ABSOLUTELY MUST BE ABLE TO ANSWER CORRECTLY. IF THEY DO NOT KNOW THE ANSWERS…RUN…DON’T WALK… RUN…TO A LENDER THAT DOES!

1) What are mortgage interest rates based on? (The only correct answer is Mortgage Backed Securities or Mortgage Bonds, NOT the 10-year Treasury Note. While the 10-year Treasury Note sometimes trends in the same direction as Mortgage Bonds, it is not unusual to see them move in completely opposite directions. DO NOT work with a lender who has their eyes on the wrong indicators.)

2) What is the next Economic Report or event that could cause interest rate movement? (A professional lender will have this at their fingertips. For an up-to-date calendar of weekly economic reports and events that may cause rates to fluctuate, visit www.timothyabbott.com and request the weekly economic update).

3) When Bernanke and the Fed “change rates”, what does this mean… and what impact does this have on mortgage interest rates? (The answer may surprise you. When the Fed makes a move, they can change a rate called the “Fed Funds Rate” or “Discount Rate”. These are both very short- term rates that impact credit cards, Home Equity credit lines, auto loans and the like. On the day of the Fed move, Mortgage rates most often will actually move in the opposite direction as the Fed change. This is due to the dynamics within the financial markets in response to inflation. For more information and explanation, just give us a call).

4) Do you have access to live, real time, mortgage bond quotes? (If a lender cannot explain how Mortgage Bonds and interest rates are moving in real time and warn you in advance of a costly intra-day price change, you are talking with someone who is still reading yesterday’s newspaper, and probably not a professional with whom to entrust your home mortgage financing. Would you work with a stockbroker who is only able to grab yesterday’s paper to tell you how a stock traded yesterday, but had no idea what the movement looks like at the present time and what market conditions could cause changes in the near future? No way!)

Be smart... Ask questions… Get answers

More than likely, this is one of the largest and most important financial transactions you will ever make. You might do this only four or five times in your entire life… but we do this every single day. It’s your home and your future. It’s our profession and our passion. We're ready to work for your best interest.

SHOPPING... PART 2

Once you are satisfied that you are working with a top-quality professional mortgage advisor, here are the rules and secrets you must know to “shop” effectively.

First, IF IT SEEMS TO GOOD TO BE TRUE, IT PROBABLY IS. But you didn’t really need us to tell you that, did you? Mortgage money and interest rates all come from the same places, and if something sounds really unbelievable, better ask a few more questions and find the hook. Is there a prepayment penalty? If the rate seems incredible, are there extra fees? What is the length of the lock-in? If fees are discounted, is it built into a higher interest rate?

Second, YOU GET WHAT YOU PAY FOR. If you are looking for the cheapest deal out there, understand that you are placing a hugely important process into the hands of the lowest bidder. Best case, expect very little advice, experience and personal service. Worst case, expect that you may not close at all. All too often, you don’t know until it’s too late that cheapest isn’t BEST. But if you want the cheapest quote – head on out to the Internet, and we wish you good luck. Just remember that if you’ve heard any horror stories from family members, friends or coworkers about missed closing dates, or big surprise changes at the last minute on interest rate or costs…these are often due to working with discount or internet lenders who may have a serious lack of experience. Most importantly, remember that the cheapest rate on the wrong strategy can cost you thousands more in the long run. This is the largest financial transaction most people will make in their lifetime. That being said – we are not the cheapest. Of course our rates and costs are very competitive, but we have also invested in the systems and team we need to ensure the top quality experience that you deserve.

Third, MAKE CORRECT COMPARISONS. When looking at estimates, don’t simply look at the bottom line. You absolutely must compare lender fees to lender fees, as these are the only ones that the lender controls. And make sure lender fees are not “hidden” down amongst the title or state fees. A lender is responsible for quoting other fees involved with a mortgage loan, but since they are third party fees – they are often under-quoted up front by a lender to make their bottom line appear lower, since they know that many consumers are not educated to NOT simply look at the bottom line! APR? Easily manipulated as well, and worthless as a tool of comparison.

Fourth, UNDERSTAND THAT INTEREST RATES AND CLOSING COSTS GO HAND IN HAND. This means that you can have any interest rate that you want – but you may pay more in costs if the rate is lower than the norm. On the other hand, you can pay discounted fees, reduced fees, or even no fees at all – but understand that this comes at the expense of a higher interest rate. Either of these balances might be right for you, or perhaps somewhere in between. It all depends on what your financial goals are. A professional lender will be able to offer the best advice and options in terms of the balance between interest rate and closing costs that correctly fits your personal goals.

Fifth, UNDERSTAND THAT INTEREST RATES CAN CHANGE DAILY, EVEN HOURLY. This means that if you are comparing lender rates and fees – this is a moving target on an hourly basis. For example, if you have two lenders that you just can’t decide between and want a quote from each – you must get this quote at the exact same time on the exact same day with the exact same terms or it will not be an accurate comparison. You also must know the length of the lock you are looking for, since longer rate locks typically have slightly higher rates.

Again, our advice to you is to be smart. Ask questions. Get answers.

As you can imagine, we wouldn’t be encouraging you to shop around if we weren’t pretty confident that we feel that we can give you a great value and serve you the very best.

Please call us with any further questions you may have at this time – we are ready to work for your best interest!

The Week Ahead in the Capital Markets

2007-07-17T10:58:13-05:00

The Week Ahead in the Capital Markets - July 16, 2007

Watch out for those super-senior tranches. Those are the upper-most credit slices of CDOs that are protected by lower, subordinate layers of credit. The AAA quality of some super-senior tranches was called in to question when the rating agencies downgraded various sub-prime issues last week. The entire universe of credit-sensitive bonds shuddered. Sub-prime mortgage bonds made up about $100 billion of the $375 billion of CDOs sold in the U.S. in 2006. The downgraded mezzanine layers of risk can be thought of as pawns protecting the king, in this case the triple-A royalty at the top of the heap, reported Barron's. When the pawns are in trouble, everyone's in trouble.

The gap widened even further between the price of good credit and bad. In the wake of last Monday's credit adjustment, spreads (and note rates) for jumbo, Alt-A, and sub-prime jumped higher. The BBB- ABX index fell off of the bottom edge of the charts. The supply of Alt-A loans has slowed to a trickle. Today's Alt-A borrowers are trying to qualify - with mixed results - for Fannie, Freddie, and Ginnie products. Pipelines remain heavily skewed towards agency products.

The stock market doesn't seem to be bothered by the sub-prime mess. The Dow sprinted to yet another record high last Thursday, and is within easy reach of 14,000. The record close was the Dow's 29^th record this year, and Thursday's rally was the biggest one-day move since October 2002. Even the beleaguered Nasdaq set a six-year high. Reasons for the rally, if you exclude the bubble mentality that has gripped stocks, reach from a not-so-bad retail sales report to the theory that stocks are a good hedge against the declining dollar.

Stock market bears urge caution. If the economy skips a beat, look out below. The common theme among economists remains the same: Inflation is still a risk, but the U.S. economy will grow at a healthy pace for the remainder of the year. Several analysts, most notably Marc Faber and John Mauldin, have begun to break ranks. The Fed "will panic" and cut rates this year to bolster the economy as sub-prime mortgage defaults climb, Faber said.

Meanwhile, Novastar has seen its stock price rise 50% in the past few months. That still leaves the sub-prime originator's stock down 70% from its 2006 high, but rumor has it that Mass Mutual sees value in Novastar's new "strategic alternatives."

The economic calendar is busy, and Bernanke speaks on Wednesday and Thursday.

Carnival of Real Estate

2007-07-16T11:51:14-05:00

A big thanks to Sadie (and Toby Boyce, of course) for selecting one of my blog entries for this week's carnival of real estate. There were a host of great entries this week, and I'm proud to have made the cut again (two weeks in a row!) even if I was 'eliminated' in the second round. Please stop by this week's carnival to see the best real estate bloggers on the web.

Weekend Roundup

2007-07-16T10:27:42-05:00

A compilation of interesting articles I ran across...

Facing a Loss at Sale? Consider the Tax Benefits of Becoming a Landlord

This Q&A explores the potential benefits of turning your home into a rental property to maximize your tax benefit.

5 Security Tips

If you'll be away this summer, your vacation planning needs to include some time and effort to make sure your house and possessions will be secure in your absence.

NAACP Suit Alleges Lenders Discriminated Against Blacks

The NAACP sued a dozen mortgage lenders claiming the companies discriminated against blacks by steering them into higher interest, subprime loans while giving more favorable loan terms to white borrowers.

When New Building Dries Up Resources

Like other fast-growing areas across the country, Effingham had to learn that large-scale expansion often comes at a price. In the county’s case, it was the long-term integrity of the vast underground water supply that serves it as well as other major areas in the South.

“The prevalent mentality that natural resources have no end has come to an abrupt halt here,” said John A. Henry, chief executive of Effingham’s Chamber of Commerce and Economic Development Authority. Because overuse of its wells could draw in saltwater, the county can no longer rely solely on the wells for business and residential use, he explained, and it has been buying water from Savannah for the last five years.

2,200 to get Reprieves on Foreclosure

Fremont Investment & Loan yesterday agreed to postpone foreclosure proceedings against 2,200 Massachusetts homeowners after state officials determined the lender gave subprime mortgages to borrowers who could not afford the loan payments.

Getting Away by Pressing the 'Up' Button

OF course, the whole idea of having a second home is to get away from it all. For most people, that involves a plane or car trip to some unspoiled corner of nature. Others, however, just take the elevator.

The Phantom Menace

Turn off all the lights in your house at night and wander around. You'll be amazed at how many devices continue to glow. Utility executives call it phantom load, the electricity that flows to devices that are turned off but still drawing power. A microwave with a clock that's on 24 hours a day. A TV that's not on but continuously consuming electricity so it's ready when you hit the remote's "on" button. Wireless phone chargers that keep drawing power even when no phone is plugged in.

Building a Pool Can Mean Taking a Bath

The surprising reality that your pool may only be worth pennies on the dollar when it comes to the value of your home.

What You Get for...$250,000

Boston Globe: State to Refinance Troubled Mortgages

2007-07-12T10:46:47-05:00

The Boston Globe business section has a fascinating article on a foreclosure bailout plan the state of Massachusetts is sponsoring. Here are the key elements:

A borrower must not be any more than 60 days delinquent on their mortgage.
The loan offered will be a fixed rate refinance at approximately 7.75%.
There are income limitations - the Boston area limit is 135% of the median income ($108K) while the rest of the state is 125% ($98K).
The value of your home can be no more than $417K for a single family home, and $645,300 for a three family.
Banks must share the pain. If a borrower purchased a house for $250K and borrowed $250K, and the value of the home has since declined to $230K, the state will only refinance $230K. The lender is expected to take a loss on the difference.

This is an incredibly intriguing proposal from where I stand. According to the article, there will be enough funds to help refinance approximately 1,000 mortgages. If you are facing a situation where the walls are closing in and you are struggling to make your mortgage payment, this could be the answer. Also, if you live in one of the neighborhoods where a house is facing a potential foreclosure, this can help the values in your area. It isn't a magic fix for values, but generally speaking distress sales (foreclosure, divorce, sudden relocation, etc) are more likely to sell below market value.

The major issue that is mentioned in the article (that I completely agree with) is that the lenders will be required to take a loss in many instances. I would think in a lot of cases it will be in the lender's best interest to accept a smaller loss in lieu of foreclosing. What happens if the lenders calculations tell them that they will be better off foreclosing than accepting what the state is offering? This is where it gets sticky. My guess is that a lot of lenders will go along with the program in order to avoid the bad press, which would not be soon forgotten in Massachusetts. People in MA tend to have good memories. Just ask someone about Bill Buckner or Bucky (bleeping) Dent.

If you have found yourself in a tough situation, this option worth exploring even if you aren't sure if you qualify. Please call NeighborhoodWorks America at (888)995-4673 as they are the organization handling things for Massachusetts.

If all else fails, please give me a call and I will help you navigate the situation. If you are unable to keep your home I have a good network of Realtors that have experience in short sales and I would be happy to give you a qualified referral.

Credit Scoring 101

2007-07-10T17:58:50-05:00

This morning I made a presentation at a professional business networking meeting. I thought this topic would be practical because it would apply to everyone in the room - we all have credit scores. I also chose this topic because I thought it had a realtively low chance of putting everyone into a coma (it was 7:30 AM and we had just eaten breakfast).

Factors that determine your credit score

35% Payment History – There are really three main components to the payment history factor - number of late payments, recency, and severity. The number of late payments is pretty self explanatory; how many late payments have you made? Recency will of course refer to how long has it has been since your last late payment. Severity deals with how late you were with your payment (30, 60 or 90+ days). The good news is that time heals all wounds in this category. The key time frames (after the last late payment) is six months, 12 months, and 24 months. A late payment loses some of its negative effect after six months, and most of its effect after 12 months. If you are able maintain a 24 month history without any more late payments, you can consider them ancient history (as far as affecting your score).

30% Outstanding Balances - This is the one area that catches most people off guard. The second biggest factor essentially boils down to: Are your credit cards maxed out? The higher the balance on your credit cards in comparison to the credit limit, the worse your score will be. A person should at least be below 50% utilization (i.e. no more than $1,000 balance on a $2,000 card) and ideally below 30%. The reasoning is that the three major credit bureaus (TransUnion, Equifax, and Experian) that compute your credit score rely on the information provided by the creditors. They don't factor in any other information (income, assets, etc). The credit bureaus assume that the credit card companies have done their homework. Thus, if you have a Capital One card and they extended to you a $5,000 credit limit, the bureaus will assume that is what you are qualified for. If you have a balance of $4,900 on the card, the bureaus will view you as being essentially tapped out and on the verge of insolvency (whether that is the case or not), and your credit score will be negatively affected.

15% Length of Credit History - This is primarily weighted towards revolving (credit card debt) but mortgage and installment loans count as well. The longer the accounts are open the better.

10% Types of Credit - Mortgage debt is considered to be the best debt, followed by installment loans (car, student), with revolving debt (credit cards) considered to be the worst. In a perfect world a person will have a good mixture of all three types of debt. As far as credit cards, typically three to five is considered to be the appropriate number to have.

10% Credit Inquiries - People are now no longer punished for rate shopping when it comes to mortgage financing and auto loans. Generally, you are allowed an ulimited number inquiries for these two reasons within a 14 day window and it will only count as one inquiry against your score (roughly a five point hit). Some of the bureaus have actually gone to a 45 day window, but we can assume all are 14 days to be conservative. Each credit card inquiry will impact your score separately and can have a very wide range - anywhere from two to 50 points.

There is a tremendous amount of misinformation and partial truths floating around and I wanted to make sure I set the record straight. This is how the credit scoring models work in a nutshell. The credit bureaus are continally tweaking the algorithm they use so this info is subject to change at any time. If you or anyone you know need assistance improving your credit, please contact me (tim@timothyabbott.com). I have standard dispute letters I would be happy to share as well as years of advice to pass along. I don't charge a penny, all I ask is that you consider me when you are in need of mortgage services.

In closing I thought I would share a few tips I've passed on to many folks. This is by no means exhaustive - I could spend all night blogging about credit if I tried to list everything.

If your credit balance is close to the limit on a credit card (ex $1,400 balance/$1,500 limit) and it is not possible to pay the balance down, ask the creditor if its possible to increase the credit limit. A $1,400 balance on a $3,000 card is much better.
Sometimes creditors will grant an extension based on payment history. Tell them you do not want a 'hard inquiry' in order to receive the increase.
If an old collection account needs to be paid off, wait until closing!! Recent activity (even paying off an old collection account) likely will lower the scores. It is an update to a negative account that should be avoided until closing.
There are several ways to leverage paying off a collection account. Many times the agencies will accept a fraction of the amount due. Sometimes it is possible to receive a 'letter of deletion' from the collection agency. Payment in full is typically required, but sometimes deleting the record permanetly is better than saving money on a settlement.
While your credit score may not be penalized for having seven, eight, nine, or even 10 credit cards open, it's a bad idea!! If you are ever the victim of identity theft, the theif has that many more accounts to steal. Keep several good cards open that you use on a regular basis. Close out all of the rest. If you really, really need to save an extra 15% off at Old Navy, open the account, pay it off, and close it out. You can always open another account during the next sale.
Credit cards typically become unrated after three months of no use (use being defined as making a charge and a payment). If the card is unrated it is no longer helping your credit score. If you have one card you use for all of your purchases, it is a good idea to use the others a couple of times a year to keep them active and helping your credit score.

The Week Ahead in the Capital Markets

2007-07-09T11:03:00-05:00

We have a world class secondary market department and they are kind enough to send out weely updates to us sales monkeys. I like posting it as it is both a great source of technical and anecdotal information. Please let me know your thoughts!

The Week Ahead in the Capital Markets - July 9, 2007

At least crude-oil prices are cooperating. Oil climbed for the fourth week in a row, and set a ten-month high of $72.81, up 44% since mid-January. Oil above $70 per barrel threatens economic growth, and slows down the ascent of interest rates.

Everything else – inflation, growth, global interest rates – is driving U.S. interest rates higher. A week ago, traders worried that the Bear Stearns-led hedge fund buyout would end in catastrophe. The buyout did not touch off a broader panic, and so interest rates reversed the previous week’s flight to quality. The ten-year Treasury had briefly ducked under 5.00%, but no more. Manufacturing activity increased for the third straight month. Payrolls expanded by 132,000 in June and kept the unemployment rate at 4.5%. Economic growth is accelerating. The Bank of England raised rates for the fifth time in the past twelve months, and cited inflation pressure as their primary motivation. More interest rate hikes are expected overseas.

All told, the Fed is on hold and unlikely to ease. Fed funds are stuck at 5.25%, and rates of all flavors will remain above 5.00% until further notice.

The $100 billion number was bandied about in the press last week. In case you were on vacation, that’s $100 billion of potential losses on sub-prime securities. Mortgage originators spent much of the first half of this year focused on changing guidelines, early payment defaults, unsaleable loans, and widening spreads. For the most part, those risks have been wrung out of the origination process. The focus of the financial markets and the financial press has now shifted to the risks facing investors – banks, hedge funds, and Wall Street firms. Barron’s and others report that “a trillion dollars of securities were issued in the past two years to fund the mortgages of less-creditworthy borrowers. The losses on these securities, which sit on the books of banks, brokerages and other financial firms, not only in the U.S. but around the world, eventually could exceed $100 billion.”

The other day at the Mexican/U.S. border, three illegal aliens were discovered under the hood of a Ford pick-up truck, crouched around the engine. When President Bush heard about it, he said, “No, that was wrong. We don't call them engines anymore. They're now Native Americans.” (Jay Leno)

Carnival of Real Estate

2007-07-09T10:19:41-05:00

Thank you very much to Marty Van Diest and the Carnival of Real Estate. I am fortunate enough to have had another blog entry selected to appear on the weekly carnival. As I mentioned before, the Carnival of Real Estate is just like a regular carnival, only lacking the rickety old rides and cotton candy. And it's also missing the strongman, bearded lady, and any exceptionally short or tall people. Actually, come to think of it I guess it's nothing like a traditional carnival. Here is brief summary from their web site as to what a carnival of blogs really is:

It’s a weekly summary of the best blogging posts on a given subject that appeared in someone’s blog during the previous week. A different blog hosts the carnival each week.

Suffice it to say that I am incredibly honored to be selected. I have always enjoyed writing and this is proving to be a great outlet and added supplement to my business. Thanks to the good folks at The Carnival of Real Estate!!

Weekend Roundup

2007-07-09T09:34:49-05:00

I had a bit of a light week last week and it gave me the opportunity to spend some time this weekend perusing the national news. I ran across a group of articles that I found tremendously informative and/or interesting and I thought I would share them with you. I hope you find them enjoyable!

Investing in real estate via your IRA

Real estate has always been permitted in IRAs, but few people know about this option. Financial institutions -- mutual funds, stock brokerages, banks -- are typically where IRAs are held. But investments in other things, most notably real estate, are fully permissible under the Employee Retirement Income Security Act of 1974. It prohibits retirement plans from investing in just two types of investments -- life insurance contracts and collectibles. Everything else is fair game.

Subprime Lenders on Notice

It won't mean the end of high-risk mortgages for subprime home buyers, but new guidance from federal financial regulators will almost certainly cut sharply the availability of some such loans.

When Foreclosure Threatens, Beware of the Bird Dogs

Mortgage foreclosures are up -- and so are the scams. Let's say you have received a letter from your mortgage lender advising that if you do not bring your payments current, the lender will have no alternative but to begin foreclosure. Within days of receiving this notice, you may get a telephone call: "Hi, my name is I.B. Scammer, and I understand that you are delinquent on your mortgage payments. You don't want to lose your beautiful home, and my company can assist you. When can I come over to explain how we operate and how we can help you?"

For Some Associations, An Easy Source of Cash

Community associations looking to raise cash can do it by shopping. A new Web site called CondoPerks rebates to registered associations a percentage of whatever their residents buy. And it's free.

New Loan Eliminates 'Junk Fees', but May Not Save You Money

There is much to admire in Bank of America's new "no-fee mortgage plus" program for home buyers, but there also are some shortcomings.

Moving These Old Houses

What to do when you just don't want to leave behind your 57 ft high Ukranian House.

The New Homeowners

Congress, presidential candidates, and lots of Americans may be giving a tepid welcome to the immigrants settling into America's neighborhoods -- some illegally, most legally. But the housing industry should be sending a welcome wagon. And every baby boomer hoping to sell his home in the next decade should be embracing these newcomers, for they will constitute an increasing segment of the home-buying, apartment-renting market. According to University of Southern California demographer Dowell Myers, immigrants and baby boomers must "forge a new social contract."

What You Get For...$7 Million

The Week Ahead in the Capital Markets

2007-07-04T17:53:13-05:00

The Week Ahead in the Capital Markets - July 2, 2007

To death and taxes, you can add this to your list of inevitabilities: the sub-prime mortgage crisis is not an isolated event. – Bill Gross

One week he scares us with thoughts of global growth and super-high interest rates; the next he says sub-prime foreclosures are going to create financial contagion and take interest rates lower. Such are the ways of Bill Gross, PIMCO’s bond king, who predicts a Fed rate cut by the end of the year. Gross’ theory is that upcoming re-sets of sub-prime loans will add to escalating delinquencies and escalating defaults, and will cause financial chaos and lower rates. He is as sure of his theory as he “is sure the sun sets in the west.” Sub-prime defaults will hurt the weaker tranches of CDOs, credit spreads will gap wider, and investors will stop buying weaker credits in mortgage, corporate, and private markets.

Meanwhile the Fed continues to follow the Taylor Rule. That’s John Taylor’s rule that recommends high interest rates when inflation is above target, and low interest rates when inflation is below target. It seems the former is currently true – inflation is above 2% and unemployment rates are low – and the Fed is not talking about any rate cut any time soon. Said one analyst, “If the Fed is concerned about inflation, so am I.” All of this despite a glimmer of hope on Friday: the personal consumption index rose only 1.9% last month, a tiny notch below the Fed’s 2.0% target.

You can forget all of that nonsense about a steep yield curve. As you can see below, the market flattened the curve (no difference between two-year and ten-year yields) in one fell swoop last week. The forecast remains somewhat the same: the ten-year Treasury yield is expected to trade between 4.75% and 5.50% as the economic data streams in, and almost everyone expects the Fed to cut rates before they raise them. The severity of the housing slump and its reverberations through the economy remain the wild cards.

The stock market, in its struggle with uncertainty and high P/E ratios, ended June with its second monthly loss in the past 13 months. Most of the selling has been in the “junk” sectors because investors are scared that the Bear Stearns hedge fund mess may be the canary in the coal mine.

The strong employment picture supports the Fed’s position. The Fed surely will not cut rates if businesses are creating jobs, and the unemployment rate is low. So this Friday’s employment report is all the more important, and expectations are for more of the same: strong job growth and low unemployment.

Earlier this week President Bush took part in the taping of the Ford's Theatre gala that will air this December on ABC. It's a Christmas show and they tape it in June. It's always awkward taping six months in advance. For example, right now President Bush is still without a clear cut strategy for Iraq. But come December ... no, I guess we'll be okay. (Jay Leno)

The $3.6 Million Mortgage

2007-07-02T17:27:06-05:00

There are few things as interesting as the mortgage market (to me, anyway). It has been a fascinating study and exercise to follow the demise of the subprime mortgage market. There have been volumes written about it here, here, and here. I am not going to take the time to rehash the discussion especially since the folks I just mentioned have done such a great job. One interesting observation I've noted more and more frequently is the complete swing of the pendulum into additional lending areas that don't quite make sense to me.

The predominant theme in 2004-2006 was to extend more and more credit to people who were less and less willing and able to repay. Well, that ship hit the mother of all icebergs (and we all know what happens then). The market is still flush with liquidity and investors don't like those funds just sitting around, so they need to find an alternative to lend money. What is the complete opposite of people with poor credit and no assets? How about wealthy people with plenty of assets.

The New York Times has a great article (here, registration req'd) documenting this phenomenon. In a nutshell, there are more and more companies blowing the roof off of traditional lending standards when it comes to multi-million dollar homes and mortgages. Let's take a look at Seth Weinstein:

"SETH WEINSTEIN is not a guy who likes to run a tab. He has only two credit cards — one for his personal use and one for business — and he says he pays them in full each month. He even wrote a check the last time he bought a car, a white Volvo convertible.

But Mr. Weinstein, who for nearly the last 30 years has developed office buildings and condominiums in the New York area, and who seems to be allergic to the idea of accumulating debt, was approved for a $3.6 million mortgage last month for the $4 million condominium he is buying at the Century at 25 Central Park West.

The loan is a two-year floating-rate mortgage that will carry payments of roughly $24,000 a month at what he estimates will be an interest rate of 8 percent through the term of the loan. He plans to refinance in two years after making some renovations on the apartment.

Mr. Weinstein chose the condominium over a similar co-op apartment, where the limit on his mortgage would have been $2 million. He said he wanted to use as little of his own money as possible to buy the apartment, preferring to invest it in Connecticut real estate, where he expects the returns to be 25 percent.

“It’s not the case that I’m cavalier about debt,” Mr. Weinstein said. “I can make a much better return on that in my business.”

It's worth noting that this article is largely anecdotal evidence and centers around New York City. Also, the gentleman referenced above is a real estate developer, but many of the people seeking these types of mortgages are investment bankers, hedge fund executives, and Gordon Gekko wannabes. For the most part these folks have been able to do no wrong in the last few years. My question is this - when the markets experience the inevitable correction, what will happen to their compensation? What will happen to their assets? I would like to think that they are all well diversified, but I don't know.

I thought this was worth mentioning because this is one of the very few instances I've found where underwriting guidelines have been loosened rather than tightened. I will continue to monitor the market and will let you know of any interesting/substantial changes that occur.

Thanks for reading and have a great holiday week!

Sub-Prime Housing Problems Limited to Just 7 States

2007-06-28T12:21:56-05:00

This picture is courtesy of Kevin Depew of Minyanville (via Barry Ritholtz of The Big Picture).

It's good to know the problems aren't as wide spread as people thought!

The Priority System of Money

2007-06-27T18:44:03-05:00

I have had the privilege and opportunity of working with numerous First Time Home Byers (FTHB) and I have always enjoyed the experience. There is generally a little more education required - that's a big part of the reason I enjoy it. Beyond the necessary home and mortgage questions, I spend a fair amount of time talking about money and general finances with my FTHB clients. I do not give specific investment advice as I am not a licensed financial planner, but I am more than equipped to introduce general strategies (I have a finance and marketing degree from Cedarville University). Once these strategies have been introduced, I happily refer my clients to a financial planner to help them continue developing the plan as well as assist with implementation.

Regardless of a client's income or background, there is a general road map that will help ensure financial success for those that follow it. It is a plan I have adopted and adapted from other mortgage and financial professionals and has proved to be extremely flexible to a client's unique situation. Obviously this is a general plan and my recommendations will vary depending on your situation. If you would like a customized mortgage solution, please don't hesitate to contact me (tim@timothyabbott.com). There are four general principles and we'll take a look at each one.

1. Establish an Emergency Fund - The first thing I recommend to clients is to get in the habit of relying on yourself rather than a credit card to get you out of a financial jam. These things come at every single one of us whether we like it or not - a new water heater, tires on the car, etc. Everyone should have a minimum of three months worth of income in a completely liquid fund (savings account) that you could access today if you needed it. If you are self-employed, paid largely by commission or bonus, or have an irregular income source you may want to have as much as six months worth of income set aside. This is strictly rainy-day money and is there to keep you out of the jaws of the 18%+ credit card monster.

2. No Debt Other than Mortgage - Once a client has put away their rainy day fund, the next step is to eliminate all non-preferred debt. This debt will be anything other than your tax-deductible mortgage. Typically credit cards should be paid off first, then auto loans, and lastly student loans. Often I'm asked whether this should be the first step instead of the second. These two steps could certainly be switched but the concern is usually a discipline issue. Some people are quite capable of paying off their bills and then committing to the savings plan. Other people freely admit that it will be a challenge. This is when we would recommend saving first (to develop the habit) and then focusing on paying down the debt. I want to help set my clients up for success and generally speaking we have a better chance if we start by saving the emergency fund first.

3. Build a Source of Liquidity - This fund will again be different for every person but it is typically equivalent to six to twelve months worth of your income. This is an ultra-critical part of the plan as these funds will allow us to deal with both good and bad opportunities. A bad opportunity is unfortunately all too easy to describe. Things such as job loss, extended leave from work (for your illness or a family member), disability, and natural disasters are all things that people face. I don't know about you, but I would much rather be prepared and have access in the event my wife or one of my daughters became ill and I needed to take some time off from work to help out. Without this fund a person would need to make some difficult choices.

Good opportunities can be more difficult to quantify. These opportunities can appear in the form of having the ability to start your own business, invest in a business with a friend or relative (that probably sounds more like a nightmare for most people!), buy a second home or investment property, or anything else that comes along. These are opportunities you would not even have a choice to make if you didn't have the funds available. Opportunity cost can be a very painful thing if you haven't experienced it before.

4. No Mortgage on Your Balance Sheet - Please notice I didn't say NO MORTGAGE. The goal is to have an asset account (401K, Roth IRA, taxable stock portfolio, etc) that equals or exceeds your mortgage balance. Once you have completed the first three steps, the additional money you have been putting away and/or paying towards debt can now be allocated towards this goal. This is generally the method that provides the greatest amount of safety, liquidity, and rate of return while giving you incredible flexibility and allowing you to have the capability of paying your mortgage off early. I will give you an example in a later post that shows the incredible power of leverage and arbitrage you command with your mortgage.

There is certainly no one size fits all approach, but this is a very good set of guidelines that will help a majority of people accomplish their financial dreams and goals. If you have any comments, constructive criticism, or general feedback, I would love to hear it!

The Week Ahead in the Capital Markets

2007-06-25T10:49:13-05:00

The Week Ahead in the Capital Markets - June 25, 2007

When the tide goes out, you find out who’s been swimming naked. – Warren Buffet

If the Bear Stearns High-Grade Structured Credit Fund wasn’t swimming naked, it was highly levered and its investments, many of which were made in sub-prime mortgages, turned against it. The fund had been doing well, posting 41 months of positive returns, until the mortgage market hit the skids. The damage worsened when investors began withdrawing funds, and culminated with a Bear-Stearns-led buyout of $3.2 billion late last week. It was the biggest rescue of a hedge fund since 1998 when more than a dozen lenders provided $3.6 billion to save Long-Term Capital Management.

The hedge fund crisis changed the bond market’s psychology yet again. As you may recall, a week ago we were concerned about global growth driving the ten-year Treasury yield to – gasp! – 5.50% or 6.00%. The yield curve was getting steeper, but only because long-term rates were rising sharply. The Fed was not expected to cut rates, and it appeared that Fed funds were stuck at 5.25%. Bill Gross shook things up by offering the possibility of a 6.50% ten-year yield within five years. The potential of higher global wages threatened our low rate world. Low wages in China and elsewhere have had a deflationary effect for years. As that labor gets “used up,” wages could push prices, inflation, and bond yields higher.

The outlook for interest rates is murky, but the consensus view holds that the ten-year yield will trade between 4.75% and 5.25% for the next few months. Last week’s uncertainty renewed hopes for a Fed ease before the end of the year. The economy is expected to grow by 2.5% and inflation is expected to hover just above 2%. Stocks are expected to have a positive year, although a sharp correction will probably happen sometime in the next six months. Housing could weaken further, but the current inventory overhang is expected to be mostly gone by early 2008.

This just in: al Qaeda is claiming credit for the vague ending of 'The Sopranos.' (David Letterman)