David Olson

FOCUS ISSUE FOR THE WEEK:  There were 10 positive vs. 14 negative trends for the week, and the negatives were more serious–a big decline in housing prices, an increase in oil prices, three declines in factory production, more discussion of a double dip in housing, and the uncertainty over the new mortgage broker compensation rule.  They were offset by a fall in the unemployment rate.  So much hinges on whether or not oil prices soar to $130+/barrel.  Several Democratic advisors said that would cause all incumbent politicians to be voted out of office—particularly the president.  Although Obama seems to have figured this out and said he is trying to encourage more domestic oil production, the sheer weight of all the regs in this country will make this difficult to accomplish.  Meanwhile, mortgage lenders are confronting their own regulatory challenges with the new Federal Reserve compensation rules that go into effect after the temporary blockage of the ruling.  The ruling was planned to go into effect on April 1, but is now stopped for several weeks.

MORTGAGE MARKET SUMMARY: The DJIA rose 1.3% to 12,376 on April 1 from 12,220 on March 25.  For the week ended March 25, mortgage applications reported by the MBA fell 7.5% from the prior week.   For the week there were 10 positive trends and 14 negative trends.

Positive Trends

• Payrolls rose by 216,000 in March which was higher than the 195,000 expected.  The unemployment rate fell to 8.8% from 8.9% in February.  This was also better than expected.  There was no change in average hourly earnings, the average workweek, or the labor force participation rate.

• Pending home sales rose 2.1% in February after declining -2.8% in January.

• Personal income rose 0.3% in February after rising a revised 1.2% in January.  This rate of growth is too low to bring first quarter GDP up to its potential.  It will be under 3% for the quarter when you add the weakness in housing and state and local government.

• Personal spending grew 0.7% in February. After subtracting inflation real spending was zero in January and 0.3% in February.  This suggests a lower GDP in 1Q11 than in 4Q10 when it grew 3.1%.  The overall personal consumption expenditure price index rose 1.6% year over year, mainly due to rising gasoline prices.  Declining consumer sentiment is expected to keep consumption demand low.

• Federal regulators proposed the following new rules for mortgage lenders defining what comprises a qualified residential mortgage:  “20% down payment for new mortgages; a 75% loan-to-value ratio for refinances, and a 70% ratio for ‘cash-out’ refinances; borrower hasn’t missed two consecutive payments on any consumer debt within two years; mortgage-related debt is no more than 28% of income, and total debt doesn’t exceed 36% of income; and fully amortizing loans.”  Loans that can’t meet these criteria would have to hold capital of 5% of the loan balance.  According to CoreLogic these new rules would exclude about 46% of all current homeowners with a mortgage.  Fannie Mae, Freddie Mac, and FHA currently hold 90% of all outstanding mortgages and would be excluded from these rules.  It is questionable that the private market could compete with them with these harsher rules.  We see little evidence of private capital interested in coming into the mortgage market.

• World events have caused the yield on the 30 YFRM to tumble to 4.81% on March 24.  Some forecasters see this yield remaining in the band of 4.5% to 5.5% for the rest of the year.  The world events were the revolts in the Middle East and the earthquake and tsunami in Japan.

• The ADP reported in March that net new jobs were 201,000 which imply that the BLS report on unemployment will likely decline for March.  The expectation of new jobs (nonfarm payrolls) for March is around 195,000.

• Initial claims for unemployment fell to 388,000 for the week ending March 23, down from 394,000 the prior week but higher than expected.  This is higher than the 4-week moving average on March 19 of 385,000 so this index implies a slight worsening of the unemployment situation.  Also, the number for March 23 will probably be revised upward next week.  Continuing claims for unemployment fell to 3,714,000, down from 3,765,000 the prior week.

• There are signs of improvement in the subprime mortgage bond market.  Prices have risen from 30 cents on the dollar to 60 cents. Nonagency bonds are earning 5% to 7%.  Jumbo loans currently earn 5% compared to 5% on agency loans.  Over the past several months the premium earned on jumbos has fallen from 130 bp to 50 bp.  Some of the firms investing in nonagency mortgage bonds are MFA Financial which is currently buying $300 million in such bonds per month.  Another is Invesco Mortgage Capital Inc., a real-estate trust.  AIG has offered to buy back a pool of nonagency bonds from the Federal Reserve which owns a portfolio of $30 billion of such loans.

• Ally Financial announced it was doing a public offering to raise capital to partially unwind its borrowing of $17.2 billion from the Treasury.  They plan to pay back $5 billion of that amount from this public offering.

Negative Trends

• Housing prices fell again in January as expected as measured by the Case Shiller survey of 20 large cities.  Prices fell on average 1.0% from December 2010 to January 2011.  They fell 3.1% from January 2010.  Prices fell in 19 of the 20 cities and only rose in Washington DC.  In Atlanta, Cleveland, Detroit, and Las Vegas prices are below January 2000 levels.  For the index as a whole, prices are now back to where they were in May 2003.  Home prices peaked in July 2006 and are now down 31.8% from that peak.  Prices had fallen that much in March 2009, then had a minor recovery, but now are back down to the level reached in March 2009.  Further declines of about 4%-5% are expected over the next 6 to 9 months.  From among these 20 cities, prices have declined the most in Las Vegas where they are now down 58% from their peak.  Prices are down the least from their peak —16.7%— in Boston.

• The consumer sentiment survey of the Conference Board fell in March to 63.4 down from 72.0 in February.  This is a sharp decline and followed an almost identical decline in the U. of Michigan consumer confidence survey.  The confidence index is back to where it was in December.  It was most influenced by the rise in gasoline prices and turmoil in the Middle East.

• Oil prices may soar to $140/barrel this spring but one positive trend is President Obama’s statement made early in March that he wants to increase domestic oil production in the short and medium run.  If he succeeds with his plan, oil prices should not rise as high.  On March 29, the U.S. price of oil was $104.18/barrel, down from $105.65 on March 25.  Due to the war in Libya, all 1.3 million barrels/day of production are blocked from being exported.  By April 1 oil on Nynex had risen to $108.14/barrel.  This is probably the key number to be watching to see if we will head into a double-dip.

• There are eight new bills recently introduced to Congress to revise Fannie Mae and Freddie Mac. The impact of these bills is to eliminate the market advantages of the GSEs and eventually eliminate them.  The Hensarling bill would reduce the size of the mortgage portfolios held by the two GSEs from $700 billion for each GSE in year one to $250 billion in year five.  The Royce bill would abolish the GSE’s affordable housing goals.  The Neugebauer bill would slowly raise the fees charged by the GSEs to guarantee mortgages against default.  The Garrett bill would strip the GSEs’ exemption from new mortgage rules mandated by the Dodd-Frank law.  John McCain plans to introduce a bill that would force the GSEs to shut down or go private within five years.  Presumably some or all of these ideas will be combined into a final bill that may be passed.  Although we think we need to reduce the role in the housing industry and taxpayers liability, is it realistic to think that the private markets would be able to fill the void left by the GSEs in five years?  The ongoing uncertainty caused by new regulations and falling property values makes it a difficult time to invest in the industry.  We suspect that private industry would need to make higher returns than the GSEs are currently making to manage the risk so a rapid change in the GSEs status could further depress an already struggling housing market.

• The rate for the ten-year Treasury rose to 3.45% on April 1, which is up since the last trough of 3.14% on March 16.

• Economist Alan Blinder foresees a 40% risk of a double dip this year based on four shocks to the economy—rising oil prices due to the Middle East crisis (especially Libya), the Japanese earthquake, European sovereign debt, and the U.S. budget deficit.  In his view, the biggest risk is from rising oil prices.

• Two mortgage trade groups (National Association of Brokers and National Association of Independent Housing Professionals) won a temporary blockage of the Federal Reserve rule that limits commissions for loan officers in mortgage transactions from taking effect on April 1. The stay will just be long enough to give the court sufficient opportunity to consider the merits of the motions for emergency relief.  But U.S. District Judge Beryl Howell rejected the groups’ request to stop the provision from taking effect, finding the public policy interests outweighed harm to the mortgage-broker industry.  This stay leaves lenders not knowing what to do and increases the uncertainty in mortgage banking.

• Jonathan Miller, an appraiser in New York City, says we have a long way to go before there will be a recovery in housing. We first have to get rid of the excess supply.  In our current business cycle, housing will be a lagging indicator.

• The Chicago PMI for March fell to 70.6, down from 71.2 in February. This is a leading indicator for industrial production and suggests it will be down for March.

• Factory orders for February fell 0.1%, down from a 3.3% growth in January.  This is bad news for GDP in 1Q11.

• The ISM index for March fell to 61.2 from 61.4 in February.

• Federal Reserve Bank of Minneapolis President Kocherlakota is hinting that the Fed will raise short term rates (the overnight rate) by 75 bp by the end of this year to stem the growth of inflation.

• A meeting will take place on March 30 between the various state attorneys general, three federal agencies, and five large banks—Bank of America, Chase, Wells Fargo, Citigroup, and Ally Financial.  The purpose is to pressure the banks to reduce the mortgage balances on the many homeowners with underwater mortgages.  It is estimated by CoreLogic that 23.1% of all homeowners with mortgages were underwater at the end of 2010.  It is not clear whether or not reducing balances diminished the probability of foreclosure although this is the hope of the government officials.  That amounts to 11.1 million households.

• Freddie Mac estimates the size of the shadow inventory of unsold homes at 1.8 million. These are homes that are delinquent and repossessed homes not on the market.  In addition, another 2 million borrowers, who were underwater more than 50%, are expected to go into foreclosure.  Then there is an enormous backlog of foreclosures that have not yet been processed, according to Lender Processing Services.  We will have to work through these numbers before there will be a genuine recovery in the housing market.

CONCLUSION: The economy is recovering but at a slower pace that in prior months.  The four big shocks (the earthquake and tsunami in Japan, economic challenges in Europe, the turmoil in the Middle East, and the U.S. budget deficit) that hit the economy this past quarter are causing oil prices to rise which will slow down economic growth and may even result in a double dip in housing.

Access Mortgage Research was founded in 1991 to provide research to the mortgage industry. For more details see www.accessmrc.com or phone 410-772-1161.