Long-term mortgage rates are back above 6 percent this morning (despite Freddie Mac’s “Fell Below 6 Percent” headline in today’s papers, the result of an early-week survey), and the definitive 10-year T-note is now 4.12 percent, a long way from the 3.85 percent bottom in the last two weeks.
A 94,000-jobs gain in November payrolls reported this morning didn’t help — the bond market was hoping ghoulishly for an off-the-table figure — but the real damage was done yesterday by the subprime workout plan. It won’t work, of course (see below), but as I said last week, signs that the government is waking to the hazard of the credit crunch will mark the bottom in long-term interest rates.
For bond and mortgage yields to go lower, even return to the Thanksgiving bottom, we will need news of deepening crunch: the failure of a bank or two one morning, or by credit market counterparties (bond or mortgage insurers); or word that the real economy is slipping to negative, or a Dow dive below 13,000.
In the Eurozone, outright bailouts are already under way: the huge HSBC took back $45 billion in bad paper it had sold, worth perhaps half that, a hit bad enough to impair its capital. Next day, business as usual. Most of the world is not as prissy as we are about the need to bail out major institutions, easily overlooking a mere shortage of capital.
The Federal Reserve will cut its overnight rate next week. If they chop a quarter of a percent, it will do nothing to help mortgages (already built in). If they chop a half a percent, it’s more likely to hurt than to help. All bond traders know to sell before the Fed ends an easing cycle; for the Fed to go below 4 percent (it’s at 4.5 percent at this minute) the credit crunch will have to deepen. I think it will, but the bond market wants to see the fact.
The subprime workout will be a blessing to any family whose home is saved. However, as an economy-wide reality, benefits from the workout will be undetectable. This episode will defy workout efforts for several reasons:
1. The primary cause of foreclosure is zero or negative equity and this is the situation today in the aftermath of a plague of idiotic and predatory, no-down-payment 100 percent lending. There’s no hope for these homes.
2. The first step in workouts is to add delinquent payments to balances and recast future payments (“capitalized interest”). See #1: no equity, no room to add.
3. Another common workout: convert to a period of interest-only payments. A ton of these troubled loans already are interest-only so this won’t work either.
4. Another traditional approach: reduce the interest rate. The FHA “streamline refi” was fabulously successful in the 1980s (available today, but only for FHA loans). Families under water or in job trouble were stuck with 14 percent loans and walking away. A streamline allowed them to refinance to then-current 8 percent rates with no proof of income and no appraisal. This won’t work today because the inventory of loans made from 2001-2006 carries average rates that are too close to today’s rates.
The Amateur Hour teams at the Fed and Treasury have missed two remedies. The obvious one: restore an adequate supply of new credit (re-guarantee Fannie Mae and Freddie Mac, expand their limits; unblock bank financial statements). Also, rate cuts, discount-window blabbing, and announcements that the crunch is loosening. Get with it, guys.
The subprime fix that would work is technical, but easy: cut the margins in the loans, existing and future. The life-of-contract “margin” in an adjustable-rate mortgage is the spread paid over index value; in “A”-quality primary residence loans it’s below 3 percent. What makes a subprime a subprime is a margin in the 5-6 percent range. The one, quick stroke of broadsword available now: limit primary residence margins to 3 percent. There would be no negotiations or re-qualifying, no work for servicers at all — simply extinguish the predatory resets.
A shriek from the right and The Street: “You can’t re-write existing contracts! You’ll damage the market!!”
The hell we can’t. We do not respect the contracts of loan sharks — by definition, terms that a borrower cannot meet. If your idea of a market for mortgage-backed securities is the back-alley knee-capping of 3 million households, we have every right to alter your “terms.”
Lou Barnes is a mortgage broker and nationally syndicated columnist based in Boulder, Colo. He can be reached at email@example.com.