FOCUS ISSUE FOR THE WEEK: The good news for the week is that there is little chance that the U.S. dollar will lose its favorable position as the world’s reserve currency. Europe and Japan are really the only two competitors for that roll. It is now clear that Greece is heading for default and the euro zone is having a major challenge hanging together. The more disciplined northern countries are tired of bailing out the less disciplined southern countries. However Europe resolves its huge problem, it will be costly and investors will head in another direction. It means at best very slow growth for Europe. The IMF forecasts their GDP to be 1.0% in 2010 and 1.5% in 2011, which is about half that of the U.S. for those two years. Japan has been weak for years and is predicted to grow at a pace between the rates for Europe and the U.S.

WORLD TRENDS: S&P downgraded Greek debt to junk status on April 27. The yield on their two year debt soared to over 25%. Angela Merkel said that Germany would only approve a Greek bailout after Greece commits to a rigid deficit-reduction plan. Greece has to accept harsh measures. Such measures would cause Greece GDP to fall 2% to 4% and their unemployment rate to rise from 11.3% to 15% or more. Barclays estimates Greece might need support of $150 billion over the next three to four years. The problems in Greece are beginning to spread to Portugal, Spain, and Ireland. S&P downgraded Portugal’s debt by two notches. Spain was downgraded on April 28. As this crisis continues it will likely result in a flight to safety in U.S. Treasurys as occurred this past week. On July 27 the yield on the 10 year Treasury fell from 3.81% to 3.71%. On April 5 it had hit a peak of 4%. The euro fell to $1.31, the lowest point in a year. One potential impact of this debt crisis is the breakup of the euro zone. Another possibility is a move to kick Greece out of the euro zone for repeated abuse of the system. However, there is no provision for such an action under their current rules. If Greece defaults total losses on their bonds are projected to be around $265 billion according to S&P. For Greece, 90% of the public debt is held by foreigners who could be expropriated by a default.

Over the past week, the DJIA fell 1% from 11,204 to 11,088. During the week there were 12 positive trends offset by 5 negative trends.

Positive Trends

• GDP for first quarter 2010 turned out as expected—3.2%. This is a respectable number and should help bring down the mammoth unemployment number without causing the Fed to raise interest rates. This GDP growth rate is down from 5.6% rate in 4Q09. Consumer spending rose 3.6% during the quarter, up from 1.6% the prior quarter. This is right in line with our forecast of 3% GDP growth for the year

• The percentage of homes that were vacant and for sale fell in 1Q10 to 2.6% from 2.7% the prior quarter reported the Census Bureau. But it is still far above the long time average of 1.6% and may increase this summer when all the foreclosures go on the market. Weakness in the housing sector is still the number one problem sector of the economy.

• Consumer confidence rose to 57.9 in April on the Conference Board index, up from 52.3 in March. This was higher than expected but still way below the level of 100 where it was in 2005-2007 before the recession began. We are slowly crawling out of the recession.

• The Consumer Sentiment Survey by the U. of Michigan rose to 72.2 for April, up from 69.5 in March. Note the similarity with the Conference Board’s findings.

• The yield on the 10-year Treasury plummeted from 3.81% last Friday to 3.71% mainly due to flight to quality of funds from Europe as the Greek debt market imploded. On April 29 it recovered to 3.73%. This low cost of funds is keeping our mortgage rates low.

• The 30 year fixed rate mortgage as measured by the Freddie Mac survey fell from 5.07% last week to 5.06%.

• Democrats agreed to kill the proposed $50 billion fund to break up large, failing financial firms. The next big challenge is whether or not banks are permitted to remain in the derivatives market. When all the many challenges to the bill are sorted out, the financial reform bill is certain to pass because the Republicans don’t have the votes to stop it completely. They can only eliminate the most egregious provisions.

• On April 28, the Federal Reserve reaffirmed its commitment to keep interest rates low. According to their statement, “growth in household spending has picked up recently but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit. . . Housing starts have edged up but remain at a depressed level.”

• Initial claims for unemployment fell to 448k for the week ending April 24, down from 459k the prior week. Continuing claims also declined to 4,645k from 4,663k the prior week. This improvement is slower than expected and again reinforces our view of a slow recovery.

• The difference in yield on five year TIPS and regular Treasurys was 1.9% on April 23. This means the market was expecting 1.9% inflation over the next five years. This is low but is higher than the negative 0.8% in November 2008. No inflationary risk evident here.

• The jumbo mortgage market is showing signs of recovery. On April 22, Redwood Trust announced plans to float a $222 million private MBS backed by jumbo loans originated by Citi. Then Wells announced it would follow with a jumbo MBS. Our firm has been talking to several midsized banks that are interested in holding more of such loans in their portfolio. At present we estimate the jumbo market at about 5%. In past years it was as large as 15% and should recover as a market for these loans opens up.

• The Chicago PMI rose to 63.8 in April up from 58.8 in March. This shows continued strength in manufacturing.

Negative Trends

• Federal tax credits for home buyers expire on April 30. The Fed stopped buying MBS at the end of March. The pace of new trial modifications under HAMP has begun to slow. The Fed has indicated that it sill start selling about $1 billion in MBS it is currently holding in its portfolio back into the market. These four efforts will cause rates to rise and mortgage demand to slow down.

• At the end of March, banks and investment trusts had an inventory of 1.1 million foreclosed homes. Another 4.8 million mortgage holders were 60+ days delinquent. This totals 5.9 million homes in trouble, up from 4.6 million a year earlier. Barclays predicts 1.6 million distressed sales of homes both in 2010 and 2011. Goldman Sachs and Barclay’s bank predicts the combined effect will be to lower home prices 5% this year. Several other major economists including Mark Zandi of Economy.com agree.

• Citigroup Inc. stock sank 3.5% on the U.S. Treasury’s plan to sell up to 1.5 billion shares as the government exits its 27 percent ownership of the bank. Within a year or so Citigroup will be a private bank again no longer partially owned by the government.

• According to LoanPerformance, national home prices fell in February 2.0% from January on a seasonally unadjusted basis. This was a steeper decline than the 1.6% decline in January from December. From peak to their February level, national home prices were now down 30.5%. They predict home prices will decline an additional 4.2% assuming the government doesn’t extend any housing price stimulus to the market.

• Home prices on the Case-Shiller index fell 0.1% in February on their seasonally adjusted 20 city index. The main difference with the LoanPerformance findings appears to be the seasonal adjustment. But prices are up 2.7% from the trough on May 2009. From the peak in July 2006 they are down 29.3%. In February, price increases in California offset decreases in most other cities. But the worst isn’t over yet for home prices. The bottom should occur this summer or fall.

CONCLUSION: Overall the housing markets ended up the week on a positive note with no short term expectations of rising interest rates, although lots of uncertainty remains due to the end of the tax credit, the impact of rising foreclosures and fears about future regulations from Washington, such as risk retention and potential new rules for sales compensation and YSPs.

Future meetings run by Access Mortgage Research:
17th Benchmark Study Meeting for the Retail and Consumer Direct Channel – May 18-20, 2010 in Milwaukee.
Access Mortgage Research was founded in 1991 to provide research to the mortgage industry. We do customized reports from databases of mortgage lenders. For more details see www.accessmrc.com or phone 410-772-1161.