The 10-year T-note fell this week all the way to 5.05 percent from its 5.26 percent top two weeks ago. Long-term mortgage rates have settled today near 6.75 percent.
The interest rate decline has had several contributors. In approximate order of importance: fear of default on widening classes of ill-advised debt has pushed money to high-quality paper; a “retracement” from the crest of a big move is normal; and gradually improving inflation data are tilting the Fed from a tight stance toward balanced.
Lastly, regarding an accelerating U.S. economy: wait a minute fellas. Home sales are still falling, and unsold inventories are up to 8.9 months’ supply, a 15-year record. Weakness in both consumer confidence and orders for durable goods put the second half of 2007 in question for anything much beyond 2 percent GDP growth.
Everyone is trying to form a housing forecast: how long, how deep, how bad will the collateral damage be? That is, everyone except for those who participated in the Great Derivatized Mortgage Train Robbery, who are doing their level best to keep everyone confused.
The forecasters have run out of metaphors. I’m waiting for these headlines: “Canary Found Dead in Iceberg,” followed by “Tip of Coal Mine Feared.” Meanwhile, the cover-uppers are selling a variety of urban legends and Tales of The West.
Legend Number One: Loosened standards in late 2005 and 2006 are responsible for the subprime damage, which will be limited to those loans. This is nonsense. We (and all other retailers) were offered the first suicide loans back in 2000, which then and now fall into two generic groups: 100 percent loan-to-value ratio in any form, with or without borrower documentation, and adjustable-rate mortgages with last-cigarette adjustment structure. The roll-out of these loans coincided exactly with Wall Street’s discovery of “credit derivatives.”
The ultimate foreclosure damage was masked by a decline in interest rates to a 50-year low, and a roaring, self-reinforcing run-up in home prices.
Legend Number Two: Fraud by Main Street lenders has been the main problem. It is a problem; it has always been a problem, and its depth is always discovered when home prices go flat. In today’s parade of mortgage horrors, fraud is not even a secondary cause. Rather, the authentic causes (back to those two generic loan types) are: if you have no equity at purchase, and prices go flat, and anything goes wrong in your household, you’re cooked. Prices went flat in 2005; that’s the problem in ’05-’06 loans, not easier credit.
Then there are the ARM-structure effects. In 2006, the Fed took short-term rates from the 1 perent bottom in 2002-2004 to 5.25 percent. ARM indices follow the Fed: in 2002-2004 a subprime borrower adjusting to 5 percent over Libor at the end of year two or three (the despicable “2/28s and 3/27s”) only went to a 6 percent or 7 percent pay rate. Now, it’s to 10 percent or 11 percent, a disaster having nothing to do with “eased standards” in 2005 and 2006 originations.
Tales of The West
Tale Number One: Housing will bottom out when home sellers finally reduce their prices enough. We better hope not because that would extinguish the equity in another 15 percent of households beyond the 15 percent that have little or none now.
Tale Number Two: Workouts, or negotiated loan modifications, will control the foreclosures. Foreclosure hotlines and counseling are doing excellent work, saving many families, but there is little negotiating room. One classic workout: add delinquent payments to the mortgage. It works if there is equity, but without any, the borrower is toast. Another is rate-reduction, which worked beautifully in the ’80s (the FHA and VA “streamline refi”) to rewrite 14-15 percent loans down to 8-9 percent. However, rate-reduction requires a lower market-rate world; today, rates are far higher than when the suicides were assisted. It may be possible to rewrite sky-high ARM adjustments, but only at the cost of deepening panic in the credit markets and cash flow collapsing. Take your poison, indolent regulators.
The next canary to hit the iceberg: S&P and Moody’s are soon to be exposed in the worst systemic rating error ever. They are going to have to re-rate hundreds of billions of new-age mortgage paper, forcing institutions to acknowledge losses beyond estimation, and in doing so will admit their own fiduciary failure: fee for blindness.
Lou Barnes is a mortgage broker and nationally syndicated columnist based in Boulder, Colo. He can be reached at firstname.lastname@example.org.