FOCUS ISSUE FOR THE WEEK: A double-dip is coming. Since the Democrats in Congress are raising tax rates (by ending the Bush tax cuts) and imposing very expensive regulations on many forms of business, especially financial companies, what else can we assume will occur? There is nothing on the horizon to pull us out of our current downturn. In his speech to Congress on Wednesday, Fed Chairman Bernanke didn’t give us any glimmer of hope. Most economists have brought their GDP forecasts down to 2.6% from 3.3% for the rest of this year. Europe’s growth rate is currently 1%. It seems likely to us that we will slow down to a 2% growth in GDP. The unemployment rate appears more likely to increase in the near term than decline. Note the sharp increase in this week’s initial claims for unemployment.

MORTGAGE MARKET SUMMARY: For the week there were 6 positive trends offset by 21 negative trends. The DJIA rose to 10,424 this week, up 3.2% from 10,097 last week. Corporate second quarter earnings have been stronger than expected which lifted the stock market.

Positive Trends

• The CPI is up 1.1% in June from a year earlier. The core CPI is up 0.9% from a year ago. That means the CPI is running well below the level the Federal Reserve would prefer to see (2%). That means the Fed will be keeping interest rates down for the next 6 to 12 months. The reasons for this declining rate of inflation are the persistently high rate of U.S. unemployment, weakness in Europe, and China’s crackdown on their overheated property prices.

• The Senate extended jobless benefits on July 20 and the House will do so on July 21. Benefits will be extended to 2.5 million Americans. This will lift the rate of the continuing claims for unemployment.

• Wells Fargo net income rose from $2.6b in 1Q10 to $3.06b in 2Q10 as credit losses and loss reserves diminished. They announced that consumer loan losses peaked in the first half and commercial loan losses will crest in the second half of the year. Income was higher than analysts expected.

• The MBA’s index of refinancing rose 8.6% in the week ending July 16 and hit its highest level in more than a year.

• GM bought subprime auto lender, AmeriCredit for $3.5b. They are the largest subprime auto credit firm. Earlier, GM was seeking to buy Ally Bank.

• The average yield on a 30 YFR mortgage fell to 4.56% this week, down from 4.57% last week according to Freddie Mac. This was the lowest rate ever according to this survey.

Negative Trends

• President Obama signed the financial reform bill into law on July 21. He is supporting Harvard Professor Elizabeth Warren as head of the Consumer Financial Protection Agency. Many bankers and Republicans oppose her. Two other candidates are Michael Barr, currently Assistant Secretary of the Treasury or Gene Kimmelman of the Justice Department.

• Bank of America’s CEO Moynihan announced that the new Financial Reform Act could cost it as much as $4 billion a year in lost revenue plus a one-time charge of $7 billion to $10 billion. This suggests the overall cost for all banks will be enormous. Another major bank confirmed that the cost would be “huge” but declined to estimate the exact number until they have had more time to study the new law.

• As of 1Q10 the top three U.S. banks (BofA, Chase, and Wells) have 33% of all U.S. bank deposits, up from 21% in mid-2007. Also in 1Q10 these three banks made 57% of all home mortgages up from 28% in 2008. Consolidation of the banking system has accelerated recently. We think the new financial reform bill will be more expensive for smaller institutions than for larger ones. There are economies of scale in managing compliance to all the new regulations.

• The National Association of Home Builder’s confidence index fell to 14 in July, down from 16 in June and 22 in May. An index reading of 50 is average. This is an assessment of current sales, future sales and foot traffic. The July reading was the lowest level in over a year.

• Housing starts fell to an annual rate of 549,000 in June down from 578,000 in May. This was the second monthly decline from a peak this year of 679,000 in April when tax incentives for home buyers ended. Demand for home-purchase mortgages are at near 14-year lows, according to the Mortgage Bankers Association, down 44% over the past two months. Home sales are improving in New York, Washington, DC, and some parts of California but tumbling in Tampa and Chicago. Fannie Mae and Freddie Mac are pushing more repossessed homes on the market. Inventories of unsold homes are increasing in many parts of the country. It now is likely that home prices on average will decline over the next six months.

• Payrolls fell in 27 states in June led by California and New York. Nevada has the highest rate of unemployment at 14.2%. Michigan is second at 13.2%. There were declines in unemployment rates in 39 states.

• More than 91,000 homeowners fell out of their government loan modifications in June, while just 38,728 received new modifications, according to the federal government. Almost 530,000 of the nearly 1.3 million government modifications have been cancelled since the program began last March. Dropouts climbed as homeowners missed payments on their modified loans or failed to turn in required paperwork.

• Sales at building supply stores were $2.6 billion, or 10% lower in June than they were in April reported the Commerce Department. This decline accounted for almost half the drop in total retail sales over that time period.

• Yield on the ten-year Treasury rose from 2.92% last week to 3.00% this week.

• Federal Reserve Chairman Bernanke called the U.S. economic outlook “unusually uncertain” but signaled the Fed wouldn’t act in the near term to bolster the flagging recovery. He expects the economy to show moderate growth this year despite a somewhat weaker outlook largely due to financial turmoil in Europe. He believes the rate of unemployment will come down very slowly and still be 7% to 7 ½% at the end of 2012.

• Consumer credit outstanding has fallen 15 of the last 16 months, including a combined $24 billion drop for April and May. This includes loans for homes, autos, credit cards, and unsecured loans. No quick turnaround is expected. This reduction will slow down retail spending since consumer incomes are rising very little if at all.

• Repurchase requests by Fannie Mae and Freddie Mac continue to rise according to the American Banker. The reasons include the borrower has other debts not disclosed to the investor and appraisal problems. Bank of America reported in its second quarter earnings report that repurchase expense rose $722 million in the second quarter to $1.2 billion.

• Initial claims for unemployment rose to 464,000 for the week ending July 17, up from 427,000 the prior week. Continuing claims were 4,487,000 down from 4,710,000. The four-week moving average of continuing claims has been flat for the past four weeks.

• The Wall Street Journal reported on July 21 that the nation’s three dominant credit-ratings providers—Moody’s, S&P, and Fitch—don’t want to issue new ratings on corporate bonds. The new financial regulatory reform bill makes bond rating firms liable for the quality of their ratings. That means that new bond sales in the $1.4 trillion market for mortgages and other consumer loans could effectively shut down.

• Existing home sales fell in June to 5.37m, from 5.66m in May. The largest regional drop was in the West of 9.3%. Newly signed contracts plunged by 30% in May from the previous month, when the tax credit expired. Inventories of unsold home rose by 2.5% in June to 3.99 million. That is an 8.9 months’ supply at the current sales pace, the highest level since August 2009.

• A national survey of real estate agents showed that traffic at homes for sale was lower in July than at any time since Credit Suisse began its survey in 2005.

• According to a recent study by MIT, the price of an average foreclosure is 27% less than a comparable home that did not go through foreclosure. By their calculations this is an average loss of $50,000. Losses in appraised value to homes within a 100 yard radius of the foreclosed house are worth an additional $200,000 on average.

• According to MacroMarkets LLC, 60% of economists polled by them now expect home prices to decline this year, which is up from 40% when they last polled in May.

• According to the Joint Center for Housing Studies of Harvard, “on average, the declines (in home prices) at the low end of the market were more than 50 percent greater than those at the high end.” (The State of the Nation’s Housing 2010, p. 8). According to Mortgage Servicing News (August 2010, p.1), “nearly 8% of African-American and Latino homeowners have already lost a home compared to 4.5% of white borrowers.” In the same paper (p. 1), it reported, “foreclosure homes accounted for 31% of all residential sales in the first quarter of 2010, and the average sales price of properties that sold while in some stage of foreclosure was almost 27% below the price of properties not in foreclosure.” The average foreclosure sales price in 1Q10 was around $150,000 (Ibid, p. 1). Also, the rate of unemployment is the biggest single cause of foreclosures and is higher for low educated workers than for high educated workers. This suggests that most foreclosures are on low priced homes and involved low educated minorities with low incomes and this explains why home prices are falling at the low end of the market more than at the high end of the market.

• According to CoreLogic, one in seven homeowners with mortgages in excess of $1m is seriously delinquent vs. one in 12 mortgages below $1m. For investor homes, 23% of mortgages over $1m are delinquent vs. 10% for investor homes under $1m. The higher priced homes are deemed more likely to go into foreclosure. Only 1% of mortgages are over $1m.

• According to Realty Trac, banks are holding onto repossessed homes, especially those worth over $300,000, for as long as two years. Two-thirds of all outstanding jumbo mortgage loans are in five states: CA, FL, NJ, VA, and NY.

Conclusion

The number of negative trends this week was three and a half times the number of positive trends which is the worst ratio since this newsletter began a year ago. The big message is that employment is not increasing rapidly enough to lower the unemployment rate, consumer sentiment is very low, bank lending is not growing, housing prices are still declining, and GDP growth is slowing down. The government has run out of strategies to energize the economy. More and more market observers are calling this slowing economy a “double-dip.”
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