David Olson and Christine Clifford

FOCUS ISSUE FOR THE WEEK

Over the past year the three overarching themes of this column have been a very weak mortgage and housing market, a slow economic recovery in the U.S. and the eventual shrinkage or collapse of the Eurozone.  We had more evidence for the last two of these themes this past week as the weakness of Europe deepened, especially in Greece.  Greek voters were unable to create a government and shifted their support to a party that doesn’t support the austerity measures that are mandatory to receive the bailout funds.  This made the European authorities warn Greece that further aid is about to be cutoff unless they strictly abide by the deal struck earlier and set off a series of negative trends across Europe:  a run on Greek bank deposits, downgrading of Greece and Eurozone banks, stock price declines, a surge of European savings into U.S. Treasuries, a decline in the euro, rising interest rates on debt and deepening recession in south European countries.

Unlike the flood of negative trends in Europe, there were some positive economic signs in the U.S.:  rising industrial production, rising housing starts, rising builder confidence, rising New York manufacturing, the lowest ten-year Treasury yield ever, falling oil and gasoline prices, flat consumer prices, and falling mortgage delinquency.

There were also some negative trends in the U.S.—falling leading indicators, slowing retail sales, falling Philadelphia manufacturing, falling building permits, rising initial claims for unemployment, falling consumer confidence, and falling stock prices especially for large U.S. banks.  This means continued slow economic growth.

For the week the DJIA fell 3.5% to 12,369 from 12,820.  There were 10 positive trends offset by 23 negative trends.

MORTGAGE MARKET SUMMARY

The MBA mortgage index reflecting new application rose 9.2% in the week of May 12, up from 1.7% growth the prior week.  The 30 YFRM yield fell to an all-time low of 3.79%.

POSITIVE TRENDS

• Industrial production rose 1.1% in April, up from -0.6% in March and much higher than expected.  Capacity utilization also jumped to 79.2 in April, up from 78.4 in March.

• Housing starts rose to a 717,000 seasonally adjusted level in April, up from a revised 699,000 level in March.  This was much higher than forecast.

• In May, the Empire Manufacturing index rose to 17.1, up from 6.6 in April and rose more than forecast.

• The National Association of Home Builders/Wells Fargo index of builder confidence rose to 29 in May, up from 25 in April, and the highest since May 2007 and higher than expected.

• Despite the turmoil in the Eurozone, the Wall Street Journal is forecasting U.S. GDP to grow about 2.2% to 3.0% in 2012, have job growth averaging 185,000/month, and the unemployment ending the year at 7.9%.  By contrast, the Eurozone will experience years of muddling over the next several year.  At present, it is virtually in recession.  Growth was negative in 4Q11 and only 0.1% in 1Q12.  The Economist magazine predicts negative growth of -0.5% for 2012.  A survey of U.S. bank officers by the Federal Reserve Bank showed that 2/3rds reported they are picking up business from European banks as they pull back their lending.

• The ten-year Treasury fell to 1.723% on May 18 as turmoil widened in Europe.  Interest rates rose in much of southern Europe.  On March 19 this yield peaked at 2.40%. 

• Oil prices continued their decline to $91.48/barrel on May 18.  Earlier this year they peaked at $110/barrel.  Strong inventories and Eurozone turmoil is causing the decline.

• The CPI was 0 in April as forecasted.  This is down from 0.3% in March.

• The Eurozone countries barely missed being in recession in 1Q12 because of strong growth in Germany.  Overall GDP for the Eurozone grew 0.1% in 1Q12 after falling 1.2% in 4Q11.  For the year the Economist magazine is predicting -0.5% for the Eurozone GDP in 2012.  Stronger net exports in Germany than expected produced the slight increase in 1Q12.

• The MBA reported that the percentage of home borrowers behind on their mortgage but not in foreclosure fell to 7.4% at the end of March, down from 8.3% a year earlier.  However, the share of mortgages in foreclosure remained unchanged at 4.4% from the previous quarter and down slightly from 4.5% a year earlier. The share of loans in foreclosure has barely changed since early 1999.

NEGATIVE TRENDS

• Initial claims for unemployment remained unchanged for the week ending May 12, but continuing claims rose to 3,265,000, up from 3,247,000 the prior week.  This signals a stalled employment picture.  These figures are higher than expected.

• In May, the index for manufacturing of the Philadelphia Fed fell 5.8% after rising 8.5% in April.  This indicates an economic slowdown in that region.

• The leading indicators published by the Conference Board fell 0.1% in April after rising 0.3% in March.

• In April, retail sales rose 0.1%, down from 0.7% in March and lower than forecast.  This slowing economic trend may be due to an early Easter and unseasonably warm weather.

• Consumer confidence dropped in the week ending May 13 to the lowest level since the end of January as slower U.S. job growth contributed to pessimism about personal finances and spending.  The Bloomberg Consumer Comfort Index fell to minus 43.6, a level associated with recessions or their aftermaths, from minus 40.4 in the previous period. The monthly expectations measure was little changed as Americans see scant improvement in the world’s largest economy.  The fourth straight decline in weekly confidence comes even as gasoline prices have retreated from an 11-month high reached in early April. The figures underscore the need for stronger job and wage gains that would help propel household spending, which accounts for about 70% of the economy.

• The European Central Bank said on May 16 it will temporarily stop lending to some Greek banks to limit its risk as President Mario Draghi signaled the ECB won’t compromise on key principles to keep Greece in the euro area.  The Frankfurt-based ECB said it will push the responsibility for lending to some Greek financial institutions onto the Greek central bank until they have sufficiently boosted their capital. “Once the recapitalization process is finalized, and we expect this to be finalized soon, the banks will regain access to standard Eurosystem refinancing operations.”   The move comes after Draghi acknowledged for the first time that Greece could leave the monetary union. While the bank’s “strong preference” is that Greece stays in the 17-nation euro area, the ECB will continue to preserve “the integrity of our balance sheet.”

• Goldman Sachs said the weak first quarter GDP growth rate of 2.2% is likely to be revised to 1.9%.  For workers under age 25, the unemployment rate In April was 16.4%

• Five of the six largest banks in the U.S. are again trading below book value.  The lowest is BofA at 0.37% of book.  Only Wells is trading above book at 1.29%.  Of the ten largest banks, US Bancorp is trading at 1.86% of book.  Investors are apparently concerned over the $2 billion hedging loss at Chase and the turmoil in Europe. According to William Isaacs, former head of FDIC, “We are creating incentives right now for institutions to get simpler, less complex and less volatile, and the market is going to be pushing people in that direction.”

• Building permits in April were 715,000, down 769,000 in March.  This suggests a flattening next month in new construction.

• In a regional election in western Germany, the Christian Democrats lost to the Social Democrats suggesting Prime Minister Merkel is losing support.  A third attempt to form a government in Greece failed.  European officials are applying pressure on Greece to stand by its fiscal commitments or face leaving the euro zone.  These officials decided to hold back part of a scheduled loan payment in a warning that future aid is imperiled by Greece’ fragmented politics.

• The euro fell some more this past week to the lowest level in three months. Bonds in Italy and Spain tumbled, with Spanish 10-year yields climbing to more than 6.2% on May 14 for the first time since Dec. 1.   Each country’s spread against German 10-year notes jumped by more than 30 basis points.  By May 18, the euro fell to $1.278.  Back last June it was $1.48, so is now down 13.6% from that peak.

• On May 14, Europe’s central bankers discussed the possibility of a Greek departure and how to handle the fallout.  Swedish Riksbank Deputy Governor Per Jansson said.  The German government has a duty to prepare for a potential Greek exit, finance ministry spokeswoman Silke Bruns said on May 18.  German Finance Minister Wolfgang Schaeuble said that turmoil in the financial markets caused by Europe’s debt crisis may last another two years, as Group of Eight leaders prepared to discuss Greece and its impact on the global economy.

• Moody’s Investor Services lowered the ratings for 26 Italian banks by one to four notches late May 14 on the country’s relapse into recession and increasingly adverse operating conditions.

• China’s economy is slowing down.  In 1Q it grew at an 8.1% pace, its slowest rate since spring of 2009.  Bank of America reduced its forecast for 2Q to 7.6% (year-over-year) from 8.5%.  Growth in industrial production slowed to 9.3% in April from 11.9% in March.  Growth in electricity output fell to 0.7%.  New residential property under construction shrank 7.9% in the year to April, from the same period in 2011.

• Contagion is spreading in Europe as more analysts foresee Greece exiting the Eurozone.  On May 18, the euro slid to $1.27.  The spread between the ten-year Spanish government bond and the German widened to 4.75 percentage point.  Also on May 14 shares of a large Spanish bank, Bankia, fell 8.9% and the overall index fell 2.7%.  Since Greece’s three major political coalitions failed to form a government, Greece may have to form a technocratic government.  Fitch said any disorderly exit by Greece from the euro would lead to widespread market disruption and severely weaker growth prospects in vulnerable economies such as Spain.

• Industrial production in the euro zone fell 2.2% in March 2012 year-over-year but the region just barely avoided a recession by growing 0.1% in 1Q.  March industrial production fell 0.3% from February.

• As expected, Ally Bank filed for bankruptcy protection for its ResCap subsidiary on May 14.  As part of the bankruptcy, Nationstar Mortgage Holdings (80% owned by Fortress Investment Group) will make a bid valued for about $2.4 billion for ResCap assets.  Ally is making a bid valued at $1.6 billion for a portfolio of ResCap loans.  Ally is 74% owned by the federal government.  Ally hopes to focus on auto-lending and online-banking.

• Greece gave up trying to form a government and called for new elections in mid-June.  The euro tumbled to a four-month low—under $1.28 on May 15.  European stocks dropped and investors sought the safety of German bonds amid speculation that Greece would be forced out and pull other countries with it, doing untold damage to the European financial system.  Syriza polled 20% of the Greek vote on May 16 making it Greece’s most popular party.  It is opposed to the bailout terms and demanding an end to fiscal restraint and economic reform.   According to Swedish Finance Minister Anders Borg “we are very close to the end of the road.”  Stock markets across the world fell on May 16 and the euro fell below $1.28.  The yield on the Spanish ten year bond rose to 6.37%, approaching the panic territory of 6.7%.  If Greece fails to comply with the conditions of its bailouts, the ECB would likely cut off the liquidity support for its banks, which could cause the Greek’s banking system’s collapse.

• Greek depositors withdrew nearly $1 billion from Greek banks on May 15.  Since January 2009 deposits by households and corporations in Greek banks have fallen 29%.  During that period the average monthly withdrawal was $2.5 to $3.5 billion but in January it jumped to $6 billion/month.  On May 15 the rate of withdrawal jumped to a $22 billion monthly rate.  There are fears that this bank run may continue and spread to other European countries.

• The most popular party in Greece says Europe is bluffing and wouldn’t dare kick Greece out of the bloc even if it spurned the terms of its bailout program.  But European Central Bank officials suggest that the Eurozone would be able to deal with the financial fallout from a Greek exit and that contagion in our struggling euro members would be manageable.  Economists say the creditor countries of Northern Europe would balk at continuing to lend Greece money if it repudiated the bailout program.  If Europe cut off its funding, Greece would repudiate its debt.  One official thought “a Greek exit would be a salutary and cleansing experience.”

• U.S. stock futures fell on May 17, following a four-day drop in the Standard & Poor’s 500 Index, as a report that Moody’s Investors Service will downgrade Spanish banks intensified concern that Europe’s debt crisis is worsening.

• On May 17 Moody’s downgraded the credit ratings of 16 Spanish banks.  Nine banks were downgraded 3 notches and 7 were downgraded one notch and kept on review for further reductions.  On May 14 Moody’s downgraded 26 Italian banks.  Also, EU announced it will temporarily cut off liquidity of Greek banks.  On May 17, there was a massive deposit withdrawal from Bankia, a large Spanish bank leading to a 50% decline in its share price.

• Greece’s credit rating was downgraded one level by Fitch Ratings on “heightened risk” that the country will not be able to sustain its membership of the euro area after inconclusive elections left the country without a stable government.

CONCLUSION

The Eurozone is heading for a crackup with likely damage for the U.S. economy but in the short run mortgage rates are at historic lows which will benefit the U.S. mortgage and housing markets.

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.