Long-term rates are off the floor: the 10-year T-note is rising toward 4.2 percent, which is taking low-fee mortgages north of 5.75 percent.

Neither perceptions of economic health nor fear or the Fed are as much to blame as awareness that rates were on the floor, and could not proceed down the basement stairs without a new, bad-news trend. If a market can’t get better, there is only one trading strategy left: sell.

Long-term rates are off the floor: the 10-year T-note is rising toward 4.2 percent, which is taking low-fee mortgages north of 5.75 percent.

Neither perceptions of economic health nor fear or the Fed are as much to blame as awareness that rates were on the floor, and could not proceed down the basement stairs without a new, bad-news trend. If a market can’t get better, there is only one trading strategy left: sell.

The economic data are OK, but just that: the purchasing managers’ index this morning described September as a hair better than August, but nothing close to the strength of last spring. Both measures of consumer confidence, from the Conference Board and the University of Michigan, have tailed in the last couple of months, both in one key aspect: the job market. Increasing scarcity of jobs in these surveys suggests another shaky payroll number next Friday from the Labor Department, and a shaky one is an absolute requirement for mortgages to stay in the fives.

Fannie Mae has stumbled into unpleasant spotlight glare. It has been caught cooking its books, not to inflate its earnings or to conceal distress, Enron-style, but to smooth them out. Fannie’s misbehavior has for the first time in its 70-year history left it without political protection from sensible regulation.

Fannie’s trillion-plus-dollar portfolio of mortgage-backed securities is thoroughly hedged, but even when the hedges work (as they have through a very tough patch in the last four years), the net value of the portfolio is a very volatile affair. By smoothing its revenue and worth, Fannie has tried to convince everyone from investors in its stock and bonds to Congress that it is safe – even stodgy – and not worth the time, effort and money to regulate.

Artificial smoothing of gains and losses is a minor offense. The great offense has been to grow its portfolio so large that if anything went wrong with its hedging, the result would put the whole financial system at risk. Critics from Federal Reserve Chairman Alan Greenspan on down have objected to Fannie’s (and Freddie’s) bloat as a pointless risk; Fannie has countered by claiming that its operations are central to the health of the housing market, and its investors have been thrilled with the returns from its special status.

Part of Fannie’s operations have been important: its uniform underwriting standards and credit guarantee of mortgage-backed securities were essential to the creation of a liquid market for home mortgages. However, Fannie’s operations as a buyer and holder of mortgages are a Depression-era relic, and its portfolio today is an entirely unnecessary exercise in corporate ego and investor greed.

Neither smoothing results nor the Justice Department’s alleged criminal investigation nor special attention from Fannie’s new regulator, the Office of Federal Housing Enterprise Oversight, did as much harm as one revelation: OFHEO investigators have found that as far back as 1998, Fannie’s smoothing operations resulted in earnings that just happened to match those required for Fannie’s executives to hit their bonus targets.

Earnings were rigged to the bonus-target penny. If the board didn’t know, it should have. An arcane argument over hedging accounting is one thing; running a quasi-federal agency as a slush fund for officers is another.

Ten years ago, a clumsy confinement of Fannie and Freddie could have caused chaos in the mortgage market, and higher rates at a minimum. Today, securitization of mortgages is old hat – we can turn any IOU into a liquid security. I won’t worry when senior Fannie officers are forced to resign, or when Fannie loses its special powers and guarantees. Mortgages and housing will be fine.

However, it does worry me that senior officers and boards of giant corporations still don’t understand that they are the stewards and guardians of our society.

Lou Barnes is a mortgage broker and nationally syndicated columnist based in Boulder, Colo. He can be reached at lbarnes@boulderwest.com.

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