Mortgage rates have enjoyed a modest rally, the 10-year T-note’s decline from 4.88 percent to 4.77 percent leading mortgages from 6.375 percent to 6.25 percent.

Do not expect more improvement, not with an economy as strong as this, and zero chance of a rate cut from the Fed. On the other hand, don’t expect the blow-up in rates that would normally follow dashed bond-market hopes for a recession, long yields soaring above the Fed’s 5.25 percent cost of money.

This unnaturally “inverted yield curve” is just one of several effects of the recycling of the American trade deficit, now in the previously inconceivable range of $750 billion per year, some 6 percent of GDP. For exporters to us to continue to export, they must keep the dollar strong enough to buy their junk (and oil), and the only way to do that is to re-invest their dollar winnings here.

There has never been anything like this before, neither magnitude nor duration, but the effects are coming clear: there is a constant bid in every financial market (commercial real estate, too), which has caused prices to rise, limited downside damage, suppressed volatility in general, compressed spreads for risk in time and credit, held long-term interest rates artificially low, and stimulated the economy.

Another effect: all of this money sloshing in makes it hard to figure out what the economy is really doing. The best economic signals used to come from financial markets, but this cash fog has everyone driving blind.

I am NOT expecting a currency crisis or other unpleasant near-term end to the recycling machine. The basic deal is too good: Asia needs jobs, and has no markets for investment comparable to ours. So long as our trade deficit is in reasonable balance with growth of asset values here, things should be OK. I am nervous that the recycling is bubbling American assets, but I’m more nervous about driving in cash fog.

Bubbling in traditional assets — stocks, bonds, office buildings — is easy to detect, and prices tend to reach common-sense limits or to correct (the one-time-only tech bubble proves the rule). However, Wall Street has filled the gap between the shortage of traditional assets and a desperate hunger for return with New Age stuff, and we have neither historical valuation guideposts nor a regulatory fabric.

Of all of the New Age stuff rolled out in the last half-dozen years, the nouveau mortgage is tops for potential investment error. It may be that the Street has done a better job of pricing and distributing risk than I think, but this week’s events moved another notch up on the bubble-risk meter.

HSBC, a British bank dating to the age of Ebenezer Scrooge, began to discover its losses — began — from playing on the American subprime freeway. This is the first indication of trouble in piggyback second mortgages. Until now, the Street has confessed only to trouble with subprime loans, and only those made in 2006, saying terms offered then had become too easy.

Nice try. 2006 was just the first year with flattening home prices. Loans made in earlier years had no tougher underwriting; they were merely protected by rising home prices. Not for long.

Appearing soon: gradual but horrifying knowledge that “A”-quality first mortgages were infected by the illusion of the Street’s risk distribution. If in 1999 we sent to any human FHA underwriter a loan application with no borrower savings, a gift of down payment, $10,000 in credit-card debt, stable employment, decent credit, rent history at $800, and a proposed new payment of $1,500, that loan would have been declined every time. “Payment shock” would have killed it. Since 2001, that loan and all of its Fannie and Freddie and private MBS cousins have been approved by Street-calibrated software. Approved every time. Not subprime — “A” paper.

Just wait, out there in the cash fog.

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

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