David Olson

FOCUS ISSUE FOR THE WEEK: Not since the fall of 2008 has the global economy been in as dangerous a position as today.  The threat of a Greek default is similar to the collapse of Lehman Brothers, which brought the near meltdown of the financial system.  So many nations are interconnected to the global finance system and trade networks that even Chinese officials are worried and are now offering to help.  Adding to this is the probable technical default of the U.S. in early August due to the inability of Congress to secure a compromise on federal spending and taxation to reduce the monumental national deficits.  Greece dodged the bullet this week with passage of the austerity measures in its parliament but it is still unlikely Greece will avoid a default on its debt sometime over the next year.  One problem is the general economic slowdown in Europe so the other stronger European countries won’t have the funds to continue to lend to Greece.  Besides these two challenges, the U.S. is trying to bring down its stubbornly high rate of unemployment.  There is the fourth challenge of global warming and the rising cost of oil.  All these challenges cost money which suggests very slow growth in the future as we confront them.

MORTGAGE MARKET SUMMARY: The MBA index of applications fell 2.7% on the week ending June 27 after dropping 5.9% the prior week.  For the week there were 12 positive trends offset by 19 negative trends.  Over the week the DJIA rose 5.4% from 11,935 to 12,581.

Positive Trends

• Pending home sales rose 8.2% in May after declining 11.3% in April, reported the National Association of Realtors.  This was a bigger increase than predicted.  Bank of America believes this marks the bottom of the home market and we will see rising sales of homes in the future.

• Greek Prime Minister Papandreou won support from parliament, 155 to 138, for his austerity program despite a massive general strike. The second bill to authorize the austerity plan also passed parliament on June 30, 155 to 136.  For the moment the Greek crisis has been averted.  Greece has already borrowed $150 billion and is low on cash.  It needs another $150 billion to pay its bills.  But this just postpones the issue of whether Greece can afford the high interest rates for its debt and be able to meet its next debt refunding.  With the passage of the austerity measures in Greece, the euro rose to $1.45. The euro ended last week at $1.4178.

• Bank of America Corp., the biggest U.S. bank, agreed to pay $8.5 billion to resolve claims made by bondholders including BlackRock Inc. over soured mortgages. This was less than the bondholders asked for.  Now similar suits may be settled by several other major banks.   It is estimated Chase will have to pay around $9 billion and Wells Fargo pay $4 billion according to an analyst at Citigroup.  Resolution of these settlements removes a cloud of uncertainty away from these banks.

• Initial claims for unemployment fell modestly this week to 428,000 from 429,000 last week. But the four-week moving average rose to 426,750 from 426,250 last week.  Continuing claims fell to 3,702,000 from 3,714,000.

• Personal income rose 0.3% in May, unchanged from the 0.3% increase in April but lower than the consensus of economists.

• State and local tax revenue grew 4.7% in the first three months of 2011 compared with the same period last year reported the Census Bureau.  This was the sixth consecutive period of year over year state and local tax revenue growth.  However non-federal tax collections still remain below pre-recession levels.

• The Chicago PMI (Purchasing Managers Index) rose to 61.1 in June, up from 56.6 in May meaning the manufacturing sector is improving.

• The national PMI rose to 55.3 in June, up from 53.5 in May.

• The price of gasoline fell to $3.54/gallon this week down from $3.61 last week. Consumers are more sensitive to this price than virtually any other and should be pleased by this decline.

• Home prices in May increased by 0.8% reported CoreLogic, the second monthly increase in a row.  As we show below, Case Shiller also reported an increase in April, using their seasonally unadjusted numbers.  CoreLogic also reports a slowly declining shadow inventory and stabilized negative equity levels.

• The price of gold is one measure of sentiment over Greece. The price of gold was $1,501/oz on June 24.  By June 28 it had fallen to $1,497.  On July 1 it was $1,487 showing relief from the immediate crisis.

• Fidelity Investments, the largest mutual fund manager in the U.S. reported that the average account balance for 401(k) plans in the U.S. rose to $74,900 as of March 31, an increase of almost 12% from last year.  This indicates people are building up their savings, which they can use to afford a home downpayment in the future.

Negative Trends

• According to research by the Wall Street Journal, the ten largest mortgage lenders in the U.S. denied 26.8% of all loan application in 2010, up from 23.5% in 2009. This is one measure of the increasing tightness of underwriting which results in declining mortgage originations.  In 4Q10 originations were $462 billion declining to $302 billion in 1Q11 and $290 billion in 2Q11.  Further declines are expected in the second half of the year.

• Many forecasters see the U.S. heading for a train crash after the August 2 on raising the debt ceiling for the U.S. Little progress has yet been made on a compromise between the two parties.  On June 1, the Minnesota government shut down due to inability for the two parties to agree on remedies.  Something similar could happen at the federal level.  Moody’s Investors Service said on June 2 that it expects to place the U.S. government’s Aaa credit rating under review for a possible downgrade if there’s no progress on the debt limit by mid-July. Fitch Ratings said June 21 it would place the U.S. on a negative rating watch if no action is taken by Aug. 2.  If these downgrades occur then U.S. interest rates will rise.  Treasury Secretary announced he will leave the administration once the debt ceiling is raised.  This will lead to uncertainty over who will replace him.

• Personal spending was flat in May, down from the 0.3% increase in April.  This was also lower than the consensus forecast of economists.  This was the second monthly decline due to limited supplies of Japanese cars, higher prices for U.S.-made cars, and higher gasoline prices.

• China expert Nicholas Lardy thinks there is a growing probability of a housing downturn in China which would cause a major correction there. About 50% of China’s GDP is linked to the fate of its real estate market.  State-owned firms have taken on heavy real estate debt.  A sharp fall in prices would produce many nonperforming loans and hurt Chinese banks.

• Money-market funds are now guaranteed by the federal government.  Half the funds today hold European bank debt which would be hurt by a Greek default. Sellers of credit-default swaps worldwide have net exposure to Greek government debt of about $5 billion.  The Treasury is saying privately that the U.S. needs to support the European bailout of Greece lest European banks fail, U.S. funds take big losses, and we get another flight from money funds as occurred in 2008 when Lehman defaulted.

• Investor concerns that time is running out have pushed up the cost of insuring European debt against default. The Markit iTraxx SovX Western Europe Index of credit default swaps on 15 governments rose 3 basis points to a record 246. Contracts tied to Greece climbed 28 basis points to 2,143, signaling an 84 percent probability of default within five years, according to Bloomberg.

• U.S. mortgage bonds without government backing are extending losses as signs of a weakening U.S. economy and concern that Greece may default on its debt curb risk-taking.  Typical prices for the senior-most securities backed by prime-jumbo mortgages that started with a few years of fixed rates fell 1.5 cents on the dollar to 79 cents last week, bringing losses over the past three months to 6 cents, Barclays Capital data show.  Similar bonds linked to Alt-A adjustable-rate mortgages dropped 1 cent to 60 cents, bringing their three-month slump to 7 cents, the data show.  Higher interest rates for nongovernment insured loans implies lower originations for that market segment in the future.

• In June 2010 the GDP growth forecast by the Federal Reserve for 2011 was 3.5% to 4.2%.  By June 2011, it has fallen to 2.7% to 2.9%.  Their forecast for 2012 in June 2010 was 3.5% to 4.5%.  By June 2011 this fell to 3.3% to 3.7%.

• Home prices continued to decline in April according to Case-Shiller, but by only 0.09% using their seasonally adjusted numbers. On this basis home prices were down 31.8% from their prior peak in April 2007.  Prices were down 3.9% year-over-year and have fallen for the past ten months in a row.  Prices fell in 11 states but rose in 9 states.  The biggest monthly declines were in Detroit, Dallas, and Boston.  The biggest year-over-year declines were in Detroit and Las Vegas.  The biggest year-over-year increases were in Washington DC and San Francisco.  On a seasonally unadjusted basis, prices rose 0.7% in April.  They were down 32.8% from their peak in July 2006.  Prices were down 4.0% year over year. Prices were up in 13 states and down in 7 states.  The deceleration in the rate of price decline suggests we may be near the trough in home prices.  However, Joshua Shapiro of MFR Inc. states: “We look for further declines to be registered in the quarters ahead, although in all likelihood the rate of deterioration will be nowhere near as steep as that recorded earlier in the cycle.”  The 9.1% rate of unemployment, high levels of foreclosures, slow growth in GDP, extremely tight underwriting and low rate of approvals of mortgages, plus low rate of consumer confidence suggests a very slow rate of recovery in home purchases and therefore further declines in home prices.  Wells Fargo expected another year of declines in home prices adding up to a further net loss of 6% to 7%.  Capital Economics believes prices won’t start rising consistently until 2014.

• The Conference Board’s index of consumer confidence in June fell to 58.5 from 61.7 in May. This was lower than expected.  There was a big drop in buying plans for houses and cars suggesting a slowdown in the second half of 2011.

• Portugal’s deficit is much higher than forecast. In 1Q11 it reached 8.7% of GDP and must be no higher than 5.9% to meet the requirements of its bailout.  This is further evidence of problems with the euro.

• The yield on the ten-year Treasury rose from 2.87% last week to 3.19%. This suggests concern over inflation and distrust in the dollar.
• The yield on the average 30-year fixed rate mortgage rose from 4.50% for the week ending June 23 to 4.51% for the week ending June 30.

• Oil prices on Nymex rose from $91.23 last week to $94.80 on July 1.

• The stock prices for the three largest banks in mortgages are down from their peaks this year. Bank of America (BAC) is down 30.2% from $15.72 in January to $10.98 on June 30.  Chase (JPM) is down 15.6% from $48.36 in February to $40.83 on June 30.  Wells (WFC) is down 17.9% from $34.25 in February to $28.13 on June 30.  This year the DJIA is down 3.8% from its peak in April.  This suggests the stock market is not encouraging for banks to expand their capital into mortgages or any other kind of loan.

• According to a survey this week by Pat Caddell, a former Democrat pollster, 39% of Americans think the U.S. economy is in permanent decline. This shows a high level of pessimism in the U.S.  Real Clear Politics says the average poll shows 64.6% of voters believe the country is heading in the wrong direction.

• Consumer sentiment for June dipped to 71.5, down from 71.8 in May reported the University of Michigan/S&P.

• More than 2 million home loans across the country are in foreclosure, and nearly 2 million more are more than 90 days delinquent.  Of those borrowers who are more than 90 days late, more than 40% have not made a payment in more than a year.  The length of time to complete a foreclosure has gotten much longer.  In New York, it now takes 924 days to foreclose, up from 263 in early 2007.  On average the time it has taken to complete a foreclosure has more than doubled to 400 days.  It will take a long time to get through all these foreclosures that are pending.

• Construction spending in May declined 0.6%, unchanged from the 0.6% decline in April reported the Census Bureau.

CONCLUSION: The economy is confronting several major problems which will slow our rate of growth.  This means slower growth in GDP over the next several years—below the long run average of 2.5% and probably some bumps.

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.