Larry Pearl and David Olson

FOCUS ISSUE FOR THE WEEK: As predicted in our last newsletter, Congress quickly passed another stimulus bill for $26 billion, and the Fed announced it will be buying Treasuries and cease lowering its holdings of government debt. Most forecasters see an economic slowdown occurring and possible deflation.

MORTGAGE MARKET SUMMARY: Economists are starting to talk about the expected slowdown in economic growth for the second quarter. This is the second estimate and the consensus is that growth might drop to 1.4% from the original first estimate of 2.4%. The economy needs to generate about 2.5% growth just to maintain unemployment at the current rate. With prospects for growth being below 2.5%, we will not see much improvement in the unemployment rate before next year.

There were 8 positive trends offset by 9 negative trends. The DJIA fell from 10,653 last week to 10,303. It lost 3.29% in the past five days. Overall, the positive trends for this week were not very strong and some people might even argue that some of the items below might be better listed as negative trends.

Positive Trends

• Per-share profit for S&P 500 companies has grown by 51 percent from the previous year and has beaten estimates at 78 percent of companies that have reported since July 12.

• Congress passed a $26.1 billion economic stimulus plan on August 10 to provide funds for state education and Medicaid programs.

• The ten year Treasury slipped to 2.69% from 2.82% the prior week and 2.91% two weeks ago.

• Retail sales for July increased by .4% after falling the previous two months. Excluding auto sales the index still increased by .2%, which says that auto sales had a good month. General motors reported profits of more than $1 billion for the quarter and plans an IPO to issue stock and pay off the government’s investment to save the company.

• The University of Michigan Consumer Sentiment Index rose for the first time in three months as the index crept up to 69.6 in July from 67.8 in June. This was inline with most economists’ estimates.

• Continuing claims for unemployment dropped by 18,000 while initial claims increase by 2,000. Since the continuing claims are for a week earlier that the initial claims, there is a good possibility that the continuing claims to rise next week.

• Consumer prices rose by .3% with its core going up by .1%. This may sound like a negative but when faced with the prospect of deflation and the recent drop of .2% in export prices (excluding agriculture items) and .3% drop for import prices (excluding oil) any small rise in the CPI is better that the alternative.

• Mortgage rates continued their decline this week, plunging to the lowest level in decades, according to surveys from Freddie Mac and Bankrate. The 30-year fixed rate slipped to 4.44%. It stood at 5.29% a year ago. There should be a slight drop in the mortgage rate next week since the ten-year treasury rate continues to fall.

Negative Trends

• The Federal Reserve Bank’s Open Market Committee said on August 10, the recovery “has slowed in recent months” and that the “pace of economic recovery is likely to be more modest in the near term than has been anticipated.” The committee repeated its commitment to keep its target for the federal funds rate, at which banks lend to each other overnight, at “exceptionally low levels” for an “extended period.” This statement caused the yield on the ten year Treasury to fall to 2.78%. On the same day, the Fed said it would reinvest the funds from its shrinking mortgage portfolio into U.S. securities of between two– and 10-year maturities. They will maintain a floor on their $2 trillion portfolio of securities and purchase $15 to $20 billion in Treasuries each month.

• The July unemployment report revealed that temporary employment declined 5,600 in July after nine straight months of growth. Usually growth in temps is a leading indicator of strength in the economy so weakness means a weakening.

• At large cap banks for the first week of August, commercial and industrial loan shrinkage slowed to -14% year over year vs. -15% the prior week (-15% vs. -8.5% at mid-sized banks). Commercial real estate loans were down -8.1% year over year, down from -8.0% last week. Consumer loans inched down in June by –0.7% month over month annualized. This equates to a 3.5% year over year shrinkage, slower than the 3.8% year over year shrinkage in prior two months.

• According to the Wall Street Journal, “The demand for asset managers will likely intensify in coming months if, as expected, banks and other lenders begin taking over billions of dollars worth of distressed commercial real estate assets. They’ll need executives to manage, lease, operate and eventually dispose of properties and bad loans. While lenders will likely try to transform existing staff into asset managers, executives who had been skilled in lending and sales may not necessarily have all the necessary skill sets.”

• Freddie Mac reported a net loss of $4.7 billion for 2Q10 and asked the U.S. Treasury to provide a $1.8 billion infusion. The government has invested a total of $63.1 billion into the firm so far. Credit losses at Freddie were $5 billion for the quarter, down only slightly from the past several quarters. Nonperforming loan volumes at Freddie continued to rise during the quarter to $118 billion, up 2% for the quarter and up 36% from a year ago. The inventory of homes owned by Fannie and Freddie has doubled over the past year to a combined 191,000. The total cost to the government for the two firms amounts to $148 billion.

• The civilian employment to population ratio during the current recession fell from a peak of 63% in 2007 to 58.4% in July. This was the largest drop since World War II. This means that we have nearly 12 million fewer jobs today than we would have if the employment-population rate were still at its 2007 level of 63%. No other recession in the past 60 years saw such rapid job destruction in either absolute or percentage terms. Only once did the employment to population ratio rise by five percentage points in a decade. That was the recovered that followed Reagan’s tax cuts in 1983. Since the Democrats are opposed to cutting taxes, that suggests a long period of recovery.

• Productivity of nonfarm U.S. workers fell 0.9% in 2Q10 from a revised 3.9% in 1Q10. This means labor costs will be rising. Unit labor costs rose 0.2% in 2Q from a decline of 3.9% in 1Q.

• Regulators meeting at the FDIC expressed concern about a provision in the new Financial Reform Act restricting the use of private credit ratings. In particular, the requirement has forced agencies to put on hold efforts to craft new capital standards for thousands of banks, particularly smaller institutions, which will likely prolong uncertainty over the rules of the road for at least a year. A spokesperson for the American Bankers Association said “Banks are really going to be in a conundrum . . . There are so many things being thrown at them all at once.” This means Congress may have to make changes in the new law very soon.

• The U.S. trade deficit widened to $49.9 billion in June from $47 billion in May as imports increased and exports fell.

Conclusion

The economy remains weak and will stay that way for the rest of the year. Falling interest rates might not stimulate growth if banks are not lending and businesses are not borrowing. Businesses are carrying huge amounts of cash on their balance sheets, and banks are irrationally tightening credit standards especially on mortgages. The recent stimulus passed by congress will help the states avoid massive layoff and may save several hundred thousand jobs over the next year.
Originator Demographic Survey: Access Mortgage Research has launched a project to support mortgage brokers and bankers. The first step of this project is to measure the size and activity of current and former mortgage brokers and mortgage bankers. A second step is to reduce the challenges of delivering loans to multiple investors and thereby increase loan pull-through rates.
Future meetings run by Access Mortgage Research:
18th Benchmark Study Meeting for the Retail and Consumer Direct Channel – September, 28-30, 2010 in Milwaukee.
18th Benchmark Study Meeting for the Broker Channel – November 2010 in Phoenix.
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