David Olson and Christine Clifford

FOCUS ISSUE FOR THE WEEK

This was a short Christmas holiday week resulting is less economic news than usual.  The major positive trends were strong retail spending, rising pending home sales, declines in initial claims for unemployment, and rising consumer confidence.  The U.S. stock market is up slightly for the year while the big stock markets elsewhere are down.  The big negatives are further declines in home prices, falling euro, rising oil prices, and the continued challenge within the eurozone.  Despite increased support from the U.S. Federal Reserve and the ECB, the yield for Italian ten-year bonds was over 7% which is unsustainable.  The price for oil on Nymex surged over $100/barrel and the euro fell to an 11 month low.  We also have the challenge of partisan gridlock in Congress and continuing spending cuts in state and local governments.  We continue to expect a partial fragmentation in the eurozone and a slow adjustment to a fiscal union among the remaining states.  The U.S. will have slow growth and Europe will have a recession.  The U.S. rate of unemployment will be moderately lower by the end of 2012.

MORTGAGE MARKET SUMMARY

Surprisingly low interest rates made 2011 a better year than most expected for the mortgage industry.  Economic woes in Europe are helping keep U.S interest rates at record lows and should help keep rates low awhile longer.  Low rates coupled with housing prices that have fallen over 30% since the July 2006 peak have pushed up housing affordability to record highs.  These conditions coupled with pent-up demand and an increase in consumer confidence are credited by NAR for a 7% increase in pending home sales in November.  Freddie Mac’s chief economist, Frank Nothaft is expecting low rates to help spur demand for refinances through HARP and purchase money demand in 2012 but does not think refinance volume will be as high as it was in 2011.  While record affordability will increase purchase volume, it will not increase sufficiently to make up for the drop off in refinance volume in second half 2012 when operation twist expires.  Freddie Mac expect total originations in 2012 to be lower than 2011.  MBA is projecting $968 billion in originations.  Fannie Mae’s economist sees a 40% chance for a double dip recession and thinks the housing market won’t improve before 2015.  Most economists are projecting a slight improvement in unemployment rates and a sluggish recovery with housing values declining somewhat further in 2012.

 For the week there were 10 positive trends and 6 negative trends.  For the week the DJIA slipped to 12,217, down 0.6% from 12,294 a week ago.

POSITIVE TRENDS

• Shares of home builders are up 30% since the end of third quarter as measured by the Dow Jones index measuring those shares.  This is higher than the 10.5% gain in the S&P500.  Many hedge funds think the worst is over and a rebound is coming.  Goldman thinks housing prices might decline by another 3% next year before beginning a rise.
• Pending home sales in November rose 7.3% indicating some improvement in the housing market.  This index had risen 10.4 in October.  “Housing affordability conditions are at a record high and there is a pent-up demand from buyers who’ve been on the sidelines, but contract failures have been running unusually high,” said NAR chief economist Lawrence Yun.
• The Chicago PMI remained virtually unchanged at 62.5 in December from 62.6 in November.  Any figure over 50 means an increase.
• Initial claims for unemployment four-week moving average continued its decline to 375,000, down from 381,000 the prior week.  For the week ending Dec. 24 rose unexpectedly to 381,000, up from 366,000 the prior week.  This was higher than expected and suggests the rapid declines in the prior month were not sustainable.  Continuing claims for unemployment also retreated unexpectedly to 3,601,000, up from 3,567,000 the earlier week.  But they were also down using a four-week moving average.  Overall, there has been a slow but fairly steady improvement in the two indicators.  This suggests moderate expansion in 2012.
• The consumer confidence index of the Conference Board rose in December to 64.5, up from 55.2 in November.  This was much higher than expected for forecasters and is at its highest level since April.  But the Bloomberg confidence index fell back to -47.5 from -45.
• Retail sales at chain stores was strong in the final week of Christmas according to the Goldman Sachs Weekly Chain Store index. 
• The U.S. economy is currently stronger than most European economies.  It has added jobs for 13 straight months and new jobless claims have been declining since the spring until this past week.  The U.S. stock market is up slightly this year whereas stocks in the German DAX are down 15%, the Brazilian Bovespa is down 17%, and the Chinese Shanghai Comp. is down 21%.
• The Federal Reserve Bank is helping to bailout European banks.  They are using temporary U.S. dollar liquidity swap arrangements with the ECB.  The interest rate is 50 bp over the overnight index swap rate.  The ECB guarantees to return the dollars at an exchange rate fixed at the time of the original swap is made.  It then lends the dollars to European banks of its choosing.  As of Dec. 21 the total swaps are $62 billion.
• General Electric Co.’s finance arm agreed to buy the U.S. retail-deposit business of insurer MetLife Inc., in a deal that matches the life insurer’s desire to get out from under federal regulation with GE’s pursuit of a more-reliable funding source.
• The U.S. Treasuries ended the year at near an all-time low as problems in Europe caused funds to stream into the U.S.   At the beginning of the year the median of 70 economists surveyed by Bloomberg were predicting the U.S. ten-year bond would yield 3.75%, but instead it ended at 1.88%.   This suggests mortgage rates will remain very low throughout 2012.

NEGATIVE TRENDS

• As we move into 2012, the biggest obstacle to economic growth in the U.S. is the eurozone crisis and the biggest voice in solving that crisis is Germany—in particular Chancellor Angela Merkel.  American officials think there are three steps needed to pull us out of this problem—1) a trillion dollar rescue fund to help weak member countries; 2) more action by the ECB to help member states in distress; and 3) a fiscal union that gives European states legal power to limit deficits run up by other member states.  At present none of these three steps look likely because of opposition in Germany.
• The Case Shiller Housing Index for October fell 1.2% from September.  Of 20 cities, prices were down in all but Phoenix.   For 20 large cities, the index was down 3.4% from a year earlier.  Since the peak in July 2006, the index is now down 32.1%.  The steepest decline was in March 2011 when it was down 33.3% from the July 2006 peak.  Using the seasonally adjusted numbers, the index is now at an all-time low of 33.0% from its peak.  The October index is down 0.6% from September.  This suggests the index is now on a decline and with all the loans in foreclosure, it is sure to fall further before it reaches its nadir.  We are expecting about another six months before this nadir is reached.  The steepest decline was in Atlanta–5.0%.
• Oil prices have moved back to around $100/barrel after falling below $80 in early October.  On Dec. 27 Nymex oil was $101.32/barrel but receded to $99 on Dec. 29.  Earlier this week Iran threatened to close the Strait of Hormuz.
• The euro fell to an 11 month low–$1.29. 
• Italy’s ten-year bonds reached 7% on Dec. 27 which is considered unsustainable.  On Dec. 29 the yield on the Italian ten year bond was 7.03%.   Italy auctioned €7 billion of debt mostly short term to bring the total raised this week to almost €20 billion, underscoring how the European Central Bank is helping the world’s fourth-biggest borrower tap markets.  In the week before Christmas the ECB lent €489 billion in three-year money to European banks.  Yields for three-year debt went for 5.62% compared with 7.89% at the Nov. 29^th auction and were a hopeful sign.  Italy must borrow €400 billion in 2012.  Italy’s total debt is €1.9 trillion and is mostly long term.  At the auction on Dec. 29 Italy sold less debt than it had hoped and most was short term.  Similarly, at a recent auction Hungary sold less than half the bonds it wanted to.
• Bank stocks were the worst performing sector in 2011.  The S&P 500 Index fell 18%, the KBW Bank Index fell 24%, Bank of American fell 59%, AIG fell 52%, Goldman Sachs fell 46%, Citicorp fell 43%, and Chase fell 21%.  This indicates how weak the banking sector is and helps explain the slow economic recovery.

CONCLUSION

We think the Eurozone will experience a crisis in 2012 which will force it to downsize and adapt more serious fiscal measures in their union.  The U.S. will benefit from continued low interest rates as money flows here from Europe which will help our housing industry.

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. 

David Olson and Christine Clifford

FOCUS ISSUE FOR THE WEEK

We wish all our readers a very happy holiday weekend and a prosperous new year.

The best news for the week was further improvement in unemployment, consumer sentiment, housing starts, existing home sales, new home sales, and builder confidence.  Finally the housing market is showing clear signs of recovery.  The bad news was a recession and more financial weakness in Europe, further weakness at Bank of America, a reduced estimate for 3Q11 GDP, and a slowdown in U.S. population growth.

MORTGAGE MARKET SUMMARY

This week interest rates fell and application volume for refinances was strong.  MBA reported that refinance share rose to an annual high of 80.7% of total applications last week.  According to Freddie Mac, average interest on a 30-year fixed mortgage slipped to a record low for the third time in 2011. The benchmark rate declined to 3.91% this week from 3.94% the previous week; the company’s records date to the 1950s.

According to the Bureau of Economic Advisors, corporate profits in the U.S. have been increasing every quarter since first quarter 2009.  Increasing profits are required for job growth and job growth and improving consumer sentiment are required for the housing market to recover.  We are beginning to see some reduction in the number of people claiming unemployment insurance and an increase in consumer sentiment.  Unemployment insurance claims fell for the past two weeks and consumer sentiment as measured by the University of Michigan has improved for the past four months.  We are also seeing some signs of improvement in the housing market.  New single family housing starts rose and existing single family home sales increased in November according to NAR.  Thanks for HARP 2.0 refinance volume should be strong in first half 2012.  If our economy continues in the current trajectory, we are likely to see a good purchase money market as well this spring.

For the week there were 11 positive trends offset by 18 negative trends.  The DJIA rose from 11,866 to 12,294.

POSITIVE TRENDS

• Initial claims for unemployment fell to 364,000 for the week ending Dec. 17, down from 368,000 the prior week.  These are very low rates and suggest another decline in the next monthly unemployment rate.  Continuing claims for unemployment for the week ending Dec. 10 fell to 3,546,000, down from 3,625,000 the prior week.
• The University of Michigan consumer sentiment index for December rose to 69.9, up from 67.7 in November.  This was the fourth consecutive monthly increase but the index hasn’t returned yet to the peak achieved in January.
• The National Association of Home Builders announced that its home builder confidence index rose from 19 in November to 21 in December.  This was higher than expected.
• Housing starts in November jumped to 685,000, compared to 627,000 in October.  This is much higher than expected.  Housing permits similarly jumped from 644,000 in October to 681,000 in November.  Most of the increase is in multifamily as families shift from purchasing homes to renting apartments.  Single-family starts rose 2.3% from October and rose 25.3% for homes with two or more units.  Purchases of low priced homes are increasing and mortgage rates are at record lows.
• Existing home sales in November rose to 4.42 million up from 4.25 million in October.  The slight growth was lower than expected.  The initial estimate for October was 4.97 million so there was a big reduction in that first estimate.
• New home sales in November were at a 315,000 annual rate, up from 310,000 in October.

• The European Central Bank will lend euro-area banks a record amount for three years in its latest attempt to keep credit flowing to the economy during the sovereign debt crisis.   The Frankfurt-based ECB awarded 489 billion euros ($645 billion) in 1,134-day loans today, the most ever in a single operation and much more than economists’ median estimate. The ECB said 523 banks asked for the funds, which will be lent at the average of its benchmark interest rate — currently 1% — over the period of the loans. They start Dec. 22.  This should provide liquidity during these trying times.
• Europe bolstered its anti-crisis arsenal, channeling 150 billion euros ($195 billion) to the International Monetary Fund as the European Central Bank widened its support for sagging bond markets.   Four countries not using the single currency also pledged to add to the IMF war chest while Britain refused to commit, preventing officials from reaching the 200 billion-euro target to ease the euro area’s home-grown debt burdens. The U.K. will “define its contribution” in early 2012, euro finance ministers said in a statement on Dec. 20.

• House Speaker John Boehner agreed to extend a U.S. payroll-tax cut past its Dec. 31 expiration, backing down under pressure from Senate Republicans and President Barack Obama.  We don’t think this extension will have that much impact on the economy since it is so short term.
• Durable goods orders rose 3.8% in November, up from 0% in October.  Excluding transportation, durable goods only rose 0.3%, which is less than the 1.5% achieved in October.
• Personal income and personal spending rose 0.1% in November.  Personal income rose  0.4% in October but personal spending was 0.1%.  These increases were less than forecast.

NEGATIVE TRENDS

• European banks are at the nexus of Europe’s sovereign crisis. Huw van Steenis and the European financials team of Morgan Stanley forecast that European banks will seek to delever their balance sheets by €1.5-2.5 trillion over the coming 18 months, with a significant impact to banks earnings, numerous asset classes and global economic recovery.

• Last week, the cost of five year paper for Italy rose to a euro-era high of 6.47%, up from 6.29% the week earlier.  There are smaller signs of cash moving out of Italy than in Greece.  Much of the exodus is occurring along the northern border.  There is concern than these early signs of exodus could increase to a flood.
• During the week of Dec. 19, the Fed is expected to support a new global framework that requires giant financial institutions to hold extra capital.  This would affect mostly banks with more than $50 billion in assets.  The large banks believe this will reduce lending and hurt the economy.
• Fitch Ratings announced on Dec. 16 it has placed all investment grade rated curozone sovereigns and their debt with Negative Outlook onto Rating Watch Negative while Moody’s went beyond any soft move to downgrade by notches to AA3 the country of Belgium.
• France’s credit outlook was lowered by Fitch Ratings, which also put the grades of nations including Spain and Italy on review for a downgrade, citing Europe’s failure to find a “comprehensive solution” to the debt crisis.
• The final estimate of GDP for 3Q11 was 1.8%, which is lower than the previous estimate of 2% and lower than expected by economists.
• Bank of America shares fell below $5 on December 19, the first time since 2009.  There are fears of negative impact from Europe. 
• Fannie Mae’s economist, Doug Duncan has a pessimistic forecast for 2012.  By the end of 2012, the unemployment rate will be 9.0%, GDP growth will be only 1.5% in 2012, and all of Europe except for Germany will be in recession.  He sees a 40% chance that the European recession will cause a double dip in the U.S.
• It is now the 20^th anniversary since the start of the euro currency in the Netherlands.  In 2009 80% of the public supported the idea and now a majority favor dropping the currency.  The rightest Freedom Party has been gaining seats in Parliament and favors dropping the euro and driving foreigners out of the Netherlands.
• Last week the SEC filed a lawsuit against the six top executives of Fannie Mae and Freddie Mac.  For the first time in a government report, the complaint has charged the two enterprises with playing a major role in creating the demand for low-quality mortgages before the 2008 financial crisis.  They charge them with hiding the size of their purchases from the market.  According to the SEC suit, in 2006 Fannie Mae adjusted its automated underwriting system to buy more lower FICO scores and higher LTV loans than previously permitted.  It was decisions like this that SEC says caused the bubble.

• Daniel Mudd, the former Fannie Mae CEO who is the subject of a new, massive SEC fraud suit, announced on Dec. 21 that he is taking a leave of absence from his current employer, Fortress Investment Group, New York.  The publicly traded FIG controls Nationstar Mortgage, Irving, Texas, a major subservicing contractor to the government-controlled Fannie. It also has been a buyer of Freddie Mac MSRs.  Until his leave of absence deal was struck, Mudd served as CEO and director of Fortress.
• U.S. mortgage bonds that lack government backing are trading at about the lowest prices in more than a year, even as riskier assets from high-yield company bonds to stocks rally, with investors bracing for sales of home-loan debt by European banks.   A group of prime jumbo-mortgage securities tracked by JPMorgan Chase & Co. as a benchmark fell to 93.3 cents on the dollar this month, the lowest level since August 2010. A set of subprime bonds tumbled to a two-year low of 28.1 cents.   Banks across Europe have pledged to cut more than 950 billion euros ($1.2 trillion) of assets during the next two years, after regulators made them increase core capital to 9 percent by June instead of in 2019, according to data compiled by Bloomberg. Combined with the greater difficulty of trading in the $1.1 trillion market of non-agency mortgage bonds and concern that the U.S. housing market has yet to bottom, the threat of the region’s banks unloading their holdings is helping to depress values.
• Bank of America Corp. spent most of the past decade building up a full suite of credit card operations, but now it is jettisoning what it can.  The bank dumped close to $1 billion in credit card assets in two separate deals announced on Dec. 21, as part of its effort to slim down and focus on its core business lines. The portfolios sold were part of B of A’s “agent-bank” business, which specializes in issuing credit cards on behalf of credit unions, smaller banks and other financial institutions.  Bank of America is shedding these assets as it tries to overcome an array of regulatory and financial problems, including widespread concerns about its capital levels, future profitability, and single-digit share price.  It is a major reversal for the company that, six years ago, paid $35 billion to buy credit card lender MBNA Corp.   Now B of A’s efforts to slim down its once-massive card operations are paying off for its smaller, healthier rivals.

• This week the California Attorney General filed suit again Fannie and Freddie seeking information on the vacant homes owned by the agencies in the state and details of what activities are occurring in those homes, such as drug dealing, prostitution, etc.  California is pressuring the two agencies to more actively write-down the balances on their loans.

• Bank of America will pay $335 million to settle allegations that its Countrywide financial Corp. unit discriminated against black and Hispanic borrowers, in the largest residential fair-lending settlement in history.
• Macroeconomic Advisers revised down its forecast for 2012 to 2.2% from 2.4%.  They assume “no extension of the payroll tax credits and an ugly event in the eurozone.”  An example of an ugly event would be the collapse of a large bank or asking Greece to leave the Eurozone.  Capital flight is intensifying from Greece since late 2009.  Greeks have pulled more than €60 billion of cash—about a quarter of total deposits—from their banks.  Between September and early November 2011, those outflows totaled nearly €14 billion, representing two of the worst months for deposit outflows.
• The Census Bureau reported that the U.S. population only grew by 2.2 million from July 2010 to July 2011 to reach a total of 311.6 million.  This was the slowest growth rate (0.71%) since the 1940s, reflecting lower immigration and a steep drop in the birthrate.  From 2000 to 2009, the population grew at an average annual rate of 0.94%.  For the period July 2009 to July 2010, it grew 2.4 million (0.78%).  This suggests slower demand for new housing.
• It is reported this week that Everbank is in negotiations to buy part of MetLife Mortgage.  MetLife has indicated it wants to exit the mortgage industry because it isn’t profitable enough.  A week ago the rumor was of PNC buying MetLife Mortgage.  The fact that neither one had yet happened suggests the market for mortgage firms is still very weak.

CONCLUSION

We expect yet another year of slow economic growth in the U.S.—probably around 2%, up from 1.7% this year–due to the European recession and weakness in housing.  But there should be no double dip in the U.S.

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.

FOCUS ISSUE FOR THE WEEK

The positive news for the week was the decline in initial claims for unemployment to the lowest level since March 2009 and rising manufacturing in the Northeast.  This was balanced by falling industrial production, falling capacity utilization, a recession in Europe, and evidence that last week’s eurozone meeting didn’t attain its goals.  It is certain Greece will have to default and exit the union.  Yields on Italy’s ten year debt rose to over 7% which is unsustainable.  Much stronger action will be needed to save the eurozone.  European banks are shedding their holdings of sovereign debt of the weaker nations.  The root problem is unwillingness to cut funding or tighten eligibility for entitlements that are no longer affordable.

MORTGAGE MARKET SUMMARY

Our economy and the mortgage industry are experiencing dramatic structural changes.  We don’t know exactly what the market will look like in a few years but we do know that it will not look like it does today with refinance volume accounting for the majority of all applications.   According to the MBA 79.7% of applications were for refinances last week and 76% two weeks ago.  Currently inflation and interest rates are at record low levels and are likely to stay there for a couple more quarters.  Can the mortgage industry use this time to retool for the future?  This is tough to do when Washington is not providing clear guidance and radical changes are being proposed like Corker and Garret’s proposal to get rid of the GSEs altogether and have FHFA regulate private securitizations.

We do know that our population growth rate is more likely to stay flat or decline since immigration rates have declined and fewer American’s are getting married and many are putting off starting a family and moving back in with their parents after college instead.  We also know that the number of multiple generation households has increased.  Increasing student loan debt and slow growth in income are making it tougher for young people to live independently.  Low interest rates on CDs have reduced retires incomes.  Doesn’t it make sense for family members to find ways to help each other financially?  Should our loan offerings change to reflect these trends?  According to NAR, 15% of first time home buyers are receiving down payment help from their parents.  Can the industry find other ways to creatively help family members work together to meet their housing needs?

The volume of foreclosures will grow throughout 2012.  Many of these homes are bought for cash by investors and kept as rental properties because vacancy rates are so low across the U.S.  Can mortgage lenders find new and improved ways to finance these investors so they can buy more homes and reduce the amount of outstanding REO.  The sooner we find ways to sell off all the foreclosures the sooner housing prices will begin to stabilize in the U.S.

To view a video of the data discussed in the summary, click here:  http://www.authorstream.com/Presentation/cclifford-1282087-weekly-mortgage-market-summary-5/

For the week there were 11 positive trends and 17 negative trends.  The DJIA fell from 12,184 last week to 11,866 this week.

POSITIVE TRENDS

• Initial claims for unemployment fell to 366,000 for the week ending Dec. 10, down from 385,000 the prior week.  The four week moving average declined to 388,000 from 394,000 a week earlier.  Continuing claims fell to 3,603,000 for the week ending Dec. 3, up from 3,599,000 the prior week showing virtually no change.
• The EU meeting in Brussels on Dec 9-10 did make some marginal improvements in dealing with the European financial crisis which have initially have been approved by the financial markets.  The main features of the agreement are:  1) a slightly stronger fiscal union with automatic consequences when a euro country exceeds the 3% of GDP deficit limit; 2) each country must pass a constitutional amendment that pledges a balanced budget and includes automatic corrections of a deficit; 3) commits the countries to put €500 billion into a European Stability Mechanism bailout fund in 2012 instead of in 2013; 4) The ESM to require future bailout recipients to restructure it or otherwise put some of the burden on its private-sector creditors; 5) their countries would put €200 billion to the IMF’s general account which would give the fund more power to help with Europe.  It will take months for this accord to go into effect.  The U.K. announced it will not participate in these agreements.
• Yields on Treasuries hit almost an all-time low (0.352%) on Dec. 12 for three-year yields as investors showed their disappointment with the European Union summit.  This shows how the U.S. will benefit in part from the European financial problem.
• Relative yields on mortgage-backed securities that guide new loan rates fell to the lowest in five months as investors wager the Federal Reserve is on standby to expand its holdings if the U.S. economy or Europe’s sovereign debt crisis worsens.
• The Federal Reserve Board of Governors met on Dec. 13 and reiterated that short term interest rates are likely to stay near zero until mid-2013, at least.  Federal Reserve Chairman Ben S. Bernanke signaled he’s concerned Europe’s crisis will hobble a 2 1/2-year U.S. expansion that may need another boost from the central bank.
• The Empire Manufacturing index rose to 9.5 in December, up from 0.61 in November showing expansion in manufacturing in the northeast.
• The Treasury on Dec. 14 sold $13 billion worth of 30-year bonds, with investors accepting a record-low yield of 2.925% at the auction. Earlier in the week, the federal government unloaded nearly $21 billion in 10-year notes at a yield of 2.02%.

 

• A bank research firm, Trepp LLC, reports that the number of bank failures is reducing.  There have been 90 so far this year and there are 227 potential failures in the future at a rate of perhaps 100 per year.  Florida, Georgia and Illinois retain their status as the failure hubs on industry observers’ lists. But several failure watchers said mini-hubs could be places such as Minnesota, Missouri, North Carolina and Tennessee.
• The CPI for November was 0% up from 0.1% in October but still essentially showing that inflation is not a problem.  The core CPI did rise to 0.2% from 0.1% but still it small.

• The Philadelphia Fed index of manufacturing rose to 10.3% in December, up from 3.6% in November which is a similar increase picked up by the New York Fed and indicates growing strength in manufacturing in the northeast.
• American Banker, reports, “Perhaps the future for loan brokers isn’t so bleak after all. Wholesale lenders table funded almost $33 billion of loans in the third quarter, giving the channel a 9.2% market share, according to new figures compiled by National Mortgage News and the Quarterly Data Report. In the first and second quarters of this year brokers had market shares of 6.8% and 7.9%, respectively. The 6.8% figure marked an all-time low for the industry. Three years ago they had a 19% share.”

NEGATIVE TRENDS

• On Dec. 12 Greece was on the brink of default and yields on Italian and Spanish debt were near unsustainable trends showing lack of success at the Brussels meeting on Dec. 9.  Yields on Italian 10 year debt rose from 6.27% to 6.44% on Dec. 11.  On the same day three large Italian labor unions went on strike over the austerity measures.  Even if all the 26 European Union members get their countries to approve the fiscal controls by limiting budget deficits, without economic growth, the objectives will not be reached.  Harvard Professor Martin Feldstein believes Europe needs country-by-country fiscal reforms and Greece should default on its debt and leave the eurozone.  The recent meeting in Brussels was a failure and didn’t achieve increased European political integration nor improve the outlook for eurozone sovereign bonds.  Also, Germany refused to raise the size of Europe’s permanent bailout fund beyond €500 billion and there is continued speculation about ratings downgrades.  Former fed vice chairman Alan Blinder thinks the European problem is huge and won’t be easily solved because its foundation is too weak.  You can’t build a monetary union without a central government strong enough to impose cross-border discipline or finance large cross-country transfers.  That implies there will be a falling apart of the eurozone next year which will likely cause a worldwide recession.

• On Dec. 9 the yield on the German ten-year bund rose from 1.97% to 2.106%.  All eyes will be watching this yield and the yield on the sovereign debts of the weaker European countries.  As of Dec 12 Investors were fleeing assets denominated in the 17-nation currency as European Union leaders failed to end concern that Italy and Spain will succumb to a sovereign-debt crisis that forced Greece, Ireland and Portugal to seek bailouts.  Fitch said a “comprehensive solution” to the euro-zone crisis is “technically and politically beyond reach.” The company said Dec. 12, without taking any action, that a European Union leaders’ summit last week did little to ease pressure on Europe’s sovereign bond ratings.  Standard & Poor’s put 15 of the 17 euro nations on “creditwatch negative” last week, pending the outcome of last week’s summit and the actions of central bankers.

• Five large banks (Ally, B of A, Citi, Chase, and Wells) are close to settling with federal and state officials over robo-signing without proper review and other foreclosure practices.  The cost would be $19 to $25 billion.
• On Dec. 12 Moody’s reiterated its intention to revisit its ratings for all EU sovereign borrowers in the first quarter of 2012.  They think the crisis is in a critical and volatile stage which policy makers will find increasingly hard to contain.
• Oil prices traded on Nymex surged from $98 to $100/barrel on Dec. 13 on news that Iran would be holding military exercises on the straits of Hormuz.  Over the past year oil reached a high of $114/barrel and a low of $76.
• On Dec 13, the Euro fell to $1.30/euro down from a high of $1.49 earlier this year.  This means the cost of our exports to Europe has risen and we will sell less to them.  Over the past year the euro peaked at $1.49 and troughed at $1.29.  Over the past five years, the euro troughed at $1.20.  A worsening of the European crisis may bring the euro down to $1.25 according to some analysts.  Barclays predicts $1.20 by the end of 2012.  It depends on how successful the resolution of the euro crisis is and how low the key lending rate of the ECB goes.  It is currently down to 1% which makes holding funds in euros less attractive to investors.  As of Dec. 13 the situation in Greece has worsened and large strikes occurred in Warsaw protesting the EU rescue plan and demanding that Poland not participate.  The Japanese Finance Minister said European leaders must do more to fix the region’s debt crisis before asking for money from the IMF.  On Dec 15, the Euro fell to $1.29.  Yields for ten year Italian bonds rose to over 7% on Dec. 15.

Retail sales rose only 0.2% in November, which is a smaller increase than during the prior two months and less than what was expected.  In October retail sales had risen 0.6% and in September they had risen 1.3%.  Even so, GDP is expected to be stronger in fourth quarter than in third quarter.

• The House voted 234-193 on Dec. 13 to extend payroll tax cuts and jobless benefits, paying in part for them by increasing guarantee fees collected by government-sponsored enterprises.  Representatives voted mostly along party lines, with most Republicans supporting the bill.  HR 3630 includes a provision to up guarantee fees charged by Fannie Mae and Freddie Mac “not less than an average increase of 10 basis points for each origination year or book year.”  The increase would offset about $35.7 billion in costs through 2021, according to a report Friday from the Congressional Budget Office.  The Mortgage Bankers Association, the National Association of Realtors and the National Association of Home Builders objected to the inclusion of the G-fees, and said any redirection of revenue for reasons unrelated to housing is counterproductive.
• European industrial production declined 0.1 percent in October after a 2% drop the previous month.  An index of euro-area manufacturing and services activity due to be published tomorrow probably fell to 46.5 in December from 47 in November, according to a Bloomberg News survey of economists.  Martin van Vliet, an economist at ING Group in Amsterdam, said the euro-region economy is “slowly but surely slipping into a new recession.”
• The PPI rose 0.3% in November, up from -0.3% in October indicating rising inflation.  The core PPI rose 0.1% in November from 0% the prior month.
• Industrial production fell 0.2% in November, after rising 0.7% in October.  Capacity utilization declined to 77.8% in November down from 78.0% in October.  This indicates weakness in November.

Banking stock analyst Dick Bove predicts U.S. banks will cut 150,000 jobs in 2012 because of the need to cut costs.  He said, “The government is beating the banks with a baseball bat.”  Interest rates are at record lows, banks can’t price cards freely, and there are big requirements to increase capital.   The Obama administration is slamming the industry as hard as it can.  Regional banks are finding that profitable growth is nearly impossible in their traditional businesses. Consequently, many are taking the untraditional approach of diversifying in areas dominated by equally beleaguered rivals.  Both Huntington and Regions are moving into indirect auto lending.  Virtually all banks are expecting a decline in mortgage lending. The Federal Housing Finance Agency will play a key role in shrinking the backlog of homes now in foreclosure, since Fannie Mae and Freddie Mac own half of all distressed loans, Fitch says in a research note. The glut of real estate-owned property held by banks and the government has hit a “staggering” 2.2 million units, and disposing of them and expediting the foreclosure process over the next two years is crucial to economic recovery. Fitch expects the FHFA to devise a plan to sell REOs at a measured pace, including in bulk to investors who would rent them out until the housing market rebounds.

• IMF Director Lagarde said the world economic outlook “is quite gloomy” with pervasive downside risk, downward revisions, slower growth than expected, higher deficits than predicted and public finances in shaky condition. “And that is pretty much true the world over, Lagarde said, and the crisis is escalating.”  Harvard Economic Professor Niall Ferguson thinks the major risk in Europe is defaults and bank failures, not inflation which is the main worry of the ECB.
• The Economist magazine opines:  “Ultimately, the eurozone faces a similar choice. Its members could strike a grand bargain that deploys the ECB’s balance-sheet and some form of Eurobond in exchange for fiscal integration. The question is not whether they can save the currency, but whether enough of them are prepared to pay the price. This summit suggests not.”
• Lending Processing Services reports there are 2.2 million homes in foreclosure plus 1.8 million that are 90+ days late.  It is this shadow inventory that will depress home prices next year.
• European banks have been selling their holdings of sovereign debt for all countries other than Germany which means the eurozone is coming apart.  This is especially true of debt of Greece, Italy, Spain, Portugal, and Ireland.  This means interest rates on this debt will continue to rise.

CONCLUSION

The hopes generated last week for resolving the eurozone crisis have largely evaporated this week.  Now we wait to see how the European nations handle their crisis and how serious the damage will be.  We think the U.S. should be able to come through with minimal damage but it still means at best slow growth for the U.S.  With our economic recovery so slow, mortgage volume will be sub-$1 trillion.

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.

David Olson and Christine Clifford

FOCUS ISSUE FOR THE WEEK

 

Two opposite trends characterize this week:  an improving U.S. economy and a crumbling eurozone trying to reform to stay alive.  The U.S. rate of unemployment fell to 8.6% in last week’s surprising news and we see further improvement this week in lower initial claims for unemployment.  Adding to this news was evidence of rising retail sales (especially autos) but still no recovery in housing or banking so we shouldn’t get overly enthusiastic yet.  On Dec. 9 at the meeting in Brussels of the Eurozone leaders, we should get a clearer view of how many European nations will support a fiscal union.  Our guess is that 16 of the 17 will support the idea but not Greece or the other 10 members that are part of the larger European Union.  Germany will dominate the new reduced fiscal union and will press its disciplined austerity measures on the other members. We then will have to watch whether bond investors will believe these pledges and whether voters in each member country will vote for the revised treaties giving Germany power over member country’s tax and spending practices.

 

MORTGAGE MARKET SUMMARY

The MBA’s weekly application index showed that last week applications shot up almost 13% versus the week before.  American consumers are choosing to reduce both their interest rate and their outstanding balances when they refinance instead of taking out more debt.  According to Freddie Mac, in third quarter 2011, 37% of people who refinanced, decreased their loan balance.  The index hit a low of 4% in second quarter 2006 and has been rising since then.  It hit a high of 44% in first quarter of this year.  Cash-in refinances are having an impact on total outstandings.  The Federal Reserve reported that total outstanding one-to-four family mortgages have declined to $9.9 trillion in third quarter down from a high of $10.5 trillion in 2007.

Consumers are reducing outstanding debt in numerous ways.  According to Federal Reserve data, outstanding debt was at 132% of disposable personal income in 2007 and it has now declined to 114% in third quarter 2011.  Average credit card balances have fallen from a high of $5,776 in Q1 2009 to $4,762 in Q3 2011 according to TransUnion.  Equifax’s November 2, 2011 National Credit Trends Report shows that total consumer debt now stands at $11.2 trillion, nearly equivalent to the $11.1 trillion posted pre-recession in 2006 according to the most recent Equifax National Credit Trends Report. Consumer debt outstanding peaked in October 2008 at $12.4 trillion.

Declining debt levels have resulting in improvements in consumers’ ability to manage their debt payments.  According to TransUnion there was a year over year decline in auto debt 60 day delinquency rates from .58% in Q3 2010 to .47% in Q3 2011 and a decline in credit card delinquency rates from .83% in Q3 2010 to .71% in Q32011.  TransUnion reported that credit card delinquency rates for borrowers 90 days or more delinquent on one or more of their credit cards reached their lowest levels in 17 years during the second quarter of 2011 (0.60%).  It expects them to remain relatively low in 2012, decreasing approximately 7% from 0.74% in the fourth quarter of 2011 to 0.69% by the end of 2012.  According to a press release from the Mortgage Bankers Association on November 17^th, the seasonally adjusted delinquency rate for mortgage loans on one-to-four-unit residential properties fell to 7.99% in the third quarter of 2011. This is the lowest level recorded since the fourth quarter of 2008.

For the week there were 11 positive trends offset by 14 negative trends.  The DJIA rose to 12,184 up from 12,019 last week.

 

POSITIVE TRENDS

 

•  Initial claims for unemployment for the week ending Dec. 3 fell to 381,000, down from 404,000 the prior week.  The four-week moving average also declined to 393,000 from 396,000 the prior week showing improvement in the employment picture.  This was the lowest level in the past nine months.  Continuing claims fell considerably to 3,583,000 for the week ending Nov. 26, down from 3,757,000 the week earlier.

 

•  Tax revenue from employee pay was up 4.8% in the third quarter from a year earlier after adjusting for changes in withholding rates over the past few years, said LaVorgna, who is the chief economist at Deutsche Bank Securities Inc. in New York. By contrast, the Commerce Department’s figures show wages and salaries climbed 2.9% over the same period.  This means the economy is stronger than reported earlier.

 

•  Auto sales rose to a 13.6 million unit annual pace in November, up from a 13.2 million rate the prior month and the highest level since August 2009, according to industry data.

 

•  The University of Michigan consumer sentiment index rose in December to 67.7, up from 64.1 in November.

 

•  The Conference Board’s Employment Trends Index jumped 1.2% to 103.7, the highest level since September 2008, from 102.4 the prior month that was more than initially estimated, figures from the New York-based private research group showed today. The measure rose 6.4% from November 2010.

 

•  Merkel and Sarkozy are talking about concrete plans to convert the eurozone to a fiscal union but are still apart on their respective proposals.  Merkel wants a strict regimen of legally binding budget discipline including automatic sanction against countries that don’t stick to their budget.  She rejects issuing euro bonds.  Sarkozy grudgingly accepts more automatic sanctions and favors issuing euro bonds.  These proposals would require changes in the current treaties of all member countries.  Can the respective countries agree in time to make such changes before the union collapses?

 

• The key Italian ten-year bond closed on Dec. 2 at 6.56%, down from 7.16% a week earlier and close to the level reached two weeks earlier.  Premier Monti outlined a new austerity plan for Italy which includes:  1) a one-time 1.5% tax on funds repatriated under Italy’s tax amnesty; 2) a 2% rise in value-added tax; 3) a rise in the retirement age for women from 60 to 66; 4) as much as €2 billion in annual tax breaks for companies that boost hiring.  However, Italy has €1.9 trillion of government debt and will need to find buyers for a mountain of new paper in 2011.  This is part of Monti’s three year plan made up of €30 billion in tax increases, spending cuts, pension overhauls and growth-boosting measures.

 

• Funding next year’s $1.3 trillion U.S. budget deficit may get a boost from Germany as bunds under perform Treasuries for the first time since the European debt crisis began in 2009.   While the U.S. needs to double bond sales to investors after the Federal Reserve reduced purchases, Treasuries due in 10 years or more are 2011’s best-performing sovereign securities, returning 26% as of Nov. 30, according to Bloomberg/EFFAS indexes.

 

• Most international investors predict at least one nation will eventually dump the euro and they say greater fiscal ties or a smaller currency area are the best fixes for the region’s debt crisis, according to the quarterly Bloomberg Global Poll taken on Dec. 6.

 

• Eurozone leaders were moving forward on bringing the proposed European Stability Mechanism start date up one year to mid-2012.  At their talks in Brussels EU leaders added 200 billion euros ($267 billion) to their crisis-fighting war chest and tightened anti-deficit rules.

 

• The ECB lowered their main policy rate to 1% undoing two increases in April and July.  The biggest question is whether Berlin will let the ECB buy up troubled sovereign bonds.

 

NEGATIVE TRENDS

 

• The euro area’s six AAA rated countries are among the nations to be placed on a negative outlook by S&P, and their credit ratings may be cut depending on the result of a summit of European Union leaders on Dec. 9.  The euro reversed its gains and U.S. Treasuries rose after the credit- ranking firm planned to reduce six AAA outlooks.  The ratings firm put Germany, France and 13 other euro-area nations on review for a downgrade, saying “continuing disagreements among European policy makers on how to tackle” the region’s debt crisis risk damaging their financial stability.  Grades may be lowered by one level for Austria, Belgium, Finland, Germany, Netherlands and Luxembourg, and as many as two steps for the other governments if the summit results don’t satisfy S&P’s criteria, the firm said.  More than $8.1 trillion of government debt would be affected if S&P does downgrade all the nations, according to data compiled by Bloomberg.  Germany and France are rated AAA.  The “negative” outlook on CC rated Greece, which is 10 steps below investment quality, wasn’t changed, as its grade “connotes our belief that there is a relatively high near-term probability of default,” S&P said. The firm kept its “negative” outlook on Cyprus’s long-term rating and placed its short-term rating on “creditwatch with negative implications.”

 

• Morgan Stanley is expecting the eurozone to slip into a recession in 4Q11.  European banks are still downsizing to shore up investor confidence and meet tighter capital standards by the middle of 2012.  Their deleveraging could amount to 10% of eurozone bank assets, says Barclays Capital.

 

• On Dec. 5, the yield for ten-year government debt in Italy fell to 5.94% from a peak of 7.36% earlier.  This shows hope that the big meeting on Dec. 9 will help solve the eurozone problem.  However, there is no plan to create euro bonds backed by a central authority able to make fiscal transfer to over-indebted regions in the eurozone.  We shall have to wait to see what is agreed at that key meeting.  A key item in the debate is financial sanctions—penalties imposed on countries running a budget deficit in excess of 3% of gross domestic product—made more automatic.  Under a proposed compromise Sarkozy and Merkel said that sanctions would apply automatically and that only a weighted majority of European countries would have the authority to reverse the punishment.  On Dec. 8 the yield on the two year debt of Italy rose 0.44 percentage points to 6.5%.  Yields also rose for French, Belgian, and Spanish debt.

 

• Factory orders fell 0.4% in October after declining 0.1% in September indicating weakness in that sector. There were decreases in electrical equipment, commercial airplanes and boats.

 

• The index for ISM services in November slipped to 52.0 from 52.9 in October indicating a slight slowdown in its recovery.

 

• Financial firms worldwide have cut more than 200,000 jobs this year, up from about 58,000 last year and 174,000 in 2009, according to data compiled by Bloomberg.  On Dec. 6 Citicorp announced plans to cut 4,500 positions.  Vikrim Pandit has cut more than 100,000 jobs since he became CEO of Citicorp in December 2007 through dismissals and sales of distressed assets and businesses. B of A plans to cut 30,000 positions over the next several years.

 

• SunTrust Banks’ top officer said Tuesday mortgage repurchase costs in fourth quarter could be “well above” those reported in prior quarters, as soured loans made during the housing boom continue to dog the Atlanta-based regional lender.  Banks have come under pressure from investors to buy back soured mortgage loans.   Investors allege the loans, packaged together into investment securities, didn’t meet the terms of the investment agreements, resulting in losses. “This is a frustrating process and it is increasingly sort of difficult to predict,” SunTrust President and CEO William Rogers told analysts during an investor conference in New York.

 

• TransUnion released a study on Dec. 7 that reveals the divergence in payment patterns — where consumers are increasingly apt to pay their credit cards before their mortgages — has now occurred for three straight years. However, for the first time since the deviation began, the percentage of consumers who are current on their credit cards and at least 30 days delinquent on their mortgage payments has declined.

 

• Over the last five years, the KBW index of 24 large-cap bank stocks is down 61% while the S&P 500 has been flat.  Year-to-date, BKX has lost nearly 23% while the S&P has gained 4.78%.  This disparity between banks and the broader market isn’t just about performance. Bank stocks also are more volatile, and many of the industry’s leading companies trade well below book value.

 

• CoreLogic, Santa Ana, Calif., said its October Home Price Index showed a decline for a third consecutive month. A separate report from Clear Capital, Truckee, Calif., said its Home Data Index Market Report improved just slightly in October, by 0.3%.  CoreLogic said home prices in the U.S. decreased 1.3% on a month-over-month basis, the third consecutive monthly decline.  According to the CoreLogic HPI, national home prices, including distressed sales, declined by 3.9 percent on a year-over-year basis.  This follows a decline of 3.8% in September from a year ago.  Excluding distressed sales, year-over-year prices declined by 0.5% in October from a year ago and by 2.1% in September compared to September 2010.  “Home prices continue to decline in response to the weak demand for housing,” said CoreLogic Chief Economist Mark Fleming. “While many housing statistics are basically moving sideways, prices continue to correct for a supply and demand imbalance.  Looking forward, our forecasts indicate flat growth through 2013.”

 

• French officials on Dec. 7 stated there is little likelihood for a broad new treaty to resolve the debt crisis among the 27 European Union members.  More likely will be an accord among the 17 eurozone members agreed to by Christmas.  The decision may come on Dec. 9 at the summit meeting.  A key plank in the Franco-German plan is to introduce more automatic sanctions on budget sinners.  This will build confidence in the Eurozone.  It might also persuade the ECB to step up intervention in government-bond markets to reverse recent selloffs and bring down borrowing costs.

 

• Household wealth in the U.S. fell from July through September for a second straight quarter as the European debt crisis depressed stocks and home values decreased.  Net worth for households and non-profit groups decreased by $2.45 trillion to $57.4 trillion, the Federal Reserve said today in its flow of funds report from Washington.  Americans reduced debt in the third quarter, extending a string of declines dating back three years.  A 14% slump in the Standard & Poor’s 500 Index, the worst quarter since 2008, combined with another decrease in households’ real estate values in the third quarter.  A rebound in stocks at the end of this year and slower home-price declines may help stabilize Americans’ balance sheets at the same time employment growth picks up.

 

• Total U.S. debt in 3Q11 was $50 trillion, down from a peak of $51 trillion in 1Q09.  Over the same period government debt has greatly increased as private debt decreased.  Over this period government debt rose from 15% to 24% of the total.  How can the federal government boost GDP without boosting the financial system?

 

• A recent Wall Street Journal poll of economists showed that they don’t see home prices exceeding the CPI until 2016.  But average home prices will start rising in 2012.

 

CONCLUSION

 

The economically advanced nations of the world are all struggling to discover how they can pay for their huge entitlements, especially in an era of slow economic growth.  What is confronting Europe will confront the U.S. very shortly.  On December 9-10 the European Union met to see if they could move closer to a fiscal union or be forced to fragment their existing monetary union.  Germany has all the clout.  Will southern Europe cede political control to them?

 

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.

David Olson and Christine Clifford

FOCUS ISSUE FOR THE WEEK

 The Economist magazine thinks the eurozone is now dead and there is little hope for its survival.  The ECB isn’t showing any willingness to massively buy sovereign debt.  Earlier in the year it raised interest rates to the already very weak countries in the south.  Southern Europe has a weak trade balance and can’t survive its current huge debt payments without being able to increase its exports.  But the combination of high and rising interest rates and enforced austerity are weakening the economies of Spain, Italy, Portugal, Greece, and Ireland.  And the contagion is spreading to Belgium, Germany and elsewhere.  The magazine predicts the breakup of the eurozone will be very messy and be similar to breakup of Yugoslavia in 1991 which reduced the member countries to poverty after the breakup.  Other breakups were Czechoslovakia and the Soviet Union.  President Obama has said the U.S. wants to support the eurozone but says the U.S. will not pledge any taxpayer funds.   Nor is China showing any interest in saving it.  Only Germany and the U.S. could potentially save it, and that is not looking possible.  On Nov. 30 the Fed lent some short term funds to six European central banks but this is viewed as merely a short term fix.  The head of the ECB outlined a fix but it requires charter changes which normally take time to do.  We think the most likely outcome is a reduced eurozone and the beginnings of a fiscal union of the stronger members.  There has to be some punishment for the widespread profligacy and abuse among the five weaker members, especially Greece.  The big question is whether this will cause a run on the banks in Greece and Italy.  There was evidence on December 2 of funds shifting from the eurozone as a whole to Scandinavia and the U.S.  The good news is evidence of a strong economy in the U.S. despite problems in Europe.

 

MORTGAGE MARKET SUMMARY

Applications for mortgages fell 11.7% in the week ending Nov. 26 from the prior week reported the Mortgage Bankers Association.  Most of the decrease was due to a decrease in refinance application activity.  Mortgage rates were little changed this past week, with the average 30-year fixed-rate mortgage at or below 4.00 percent for the fifth consecutive week according to Freddie Mac.  Case Shiller reported that home prices fell again in September.  Prices were down 32.5% from the peak in April 2006.  They were down 3.6% from a year ago.  Perhaps the extraordinarily low rates coupled with low housing prices helped spur housing activity.  The National Association of Home Builders (NAHB)

reported increased sales of new homes and The National Association of Realtors (NAR) reported an increase in pending home sales in October.

For the week the DJIA rose from 11,231 last week to 12,019 this week.  For the week there were 19 positive trends offset by 15 negative trends.

 

POSITIVE TRENDS

 

• The rate of unemployment plunged to 8.6% in November, down from 9.0%.  This surprising decline occurred even though nonfarm payrolls only rose 120,000.  The average workweek remained unchanged at 34.3 hours.  Average hourly earnings fell 0.1%.  There was a drop of 315,000 people out of the labor force in November plus an increase of 172,000 in population which accounted for most of the unemployment decline.  In a normal month, you would need 150,000 new jobs to employ the growth in the population.  The household survey counted an increase in total employment of 278,000 which is much higher than the 120,000 from the establishment survey.  There was a surge of nearly 50,000 retail jobs that are probably due to rising expectations of Christmas sales.  Growth in temps and health care also accounted for the improvement.  Revisions to prior reports added a total of 72,000 jobs to payrolls in September and October.

 

• Retail sales rose 6.6% on Black Friday (the day after Thanksgiving) suggesting improved consumer confidence.

• The ISM index for the U.S. rose to 52.7 for November, up from 50.8 in October.  Again this shows modest growth in manufacturing.
• Pending home sales in October rose 10.4%, up from a decline of 4.6% in September, reported the National Association of Realtors.
• The Federal Reserve in its beige book report of Nov. 30 reported that the economy grew in most parts of the U.S. in October and the first part of this month, though hiring remained subdued, suggesting a slow if increasingly steady recovery.  Most Fed districts described the pace of growth as slow or moderate.  Contacts generally noted modest increases in consumer spending, stronger tourism activity, a steadily expanding manufacturing sector, sluggish real-estate and construction markets, and stable wages and salaries since the previous beige book was released Oct. 19.
• Construction spending rose 0.8% in October, after rising 0.2% in September.  This is a very modest improvement in construction.
• Consumer confidence measured by the Conference Board soared to 56 in November from 40.9.  This was much higher than expected.  It may reflect strong retail sales over Thanksgiving.  But stock market declines later in November suggest this was a one month blip.

• Eurozone leaders are negotiating a fiscal pact that would make budget discipline legally binding and enforceable by European authorities.  The move, which hasn’t yet been agreed to, would be a first step toward closer fiscal and economic coordination within the currency area.  Officials hope the new agreement would persuade the ECB to undertake more drastic action to reverse the recent sell-off in eurozone debt markets.  If agreement is reached, a pact could be announced before the next European summit in early December and could come into force as soon as early 2012.  One idea is for the ECB to lend to the IMF who in turn would lend directly to the troubled eurozone countries.  The IMF is backed by many more countries than the ECB and could help stem the crisis.

 

• The head of the ECB, Mario Draghi, has been increasing his funding of southern European members of the eurozone but said before he will increase more they must accept a tighter union bound by enforceable fiscal rule and the alignment of economic policies.  The ECB mandate calls for it to keep inflation just below 2%.  It is forbidden from financing government debt.  Even so, ECB officials have significant scope to scale up their purchases without breaking the law. Over the last several weeks they have bought around $10 billion per week.  If purchases are for monetary policy purposes there is apparently no legal constraint their size.  There is a feeling that the ECB will lower interest rates for a second straight time when it meets next week to 1% from 1.25%.

 

• The biggest bond dealers in the U.S. say the Federal Reserve is poised to start a new round of stimulus (QE3), injecting more money into the economy by purchasing mortgage securities instead of Treasuries. Fed Chairman Ben S. Bernanke and his fellow policy makers, who bought $2.3 trillion of Treasury and mortgage-related bonds between 2008 and June, will start another program next quarter, 16 of the 21 primary dealers of U.S. government securities that trade with the central bank said in a Bloomberg News survey last week. The Fed may buy about $545 billion in home-loan debt, based on the median of the 10 firms that provided estimates.

• According to the National Association of Realtors, the apartment rental market – multifamily housing – is expected to see vacancy rates drop from 5.0% in the fourth quarter to 4.3% in the fourth quarter of 2012; multifamily vacancy rates below 5% generally are considered a landlord’s market with demand justifying higher rents.  Areas with the lowest multifamily vacancy rates currently are Minneapolis, 2.4%; New York City, 2.7%; and Portland, Ore., at 2.8%.  Average apartment rent is projected to rise 2.5% this year and another 3.5% in 2012. Multifamily net absorption is likely to be 238,400 units this year and 126,600 in 2012.  The remainder of commercial real estate is not as strong but is expected to grow as the overall economy expands.  In 4Q11, office vacancies are 16.7% and industrial vacancies are 12.7%.
• CoreLogic released negative equity data showing that 10.7 million, or 22.1%, of all residential properties with a mortgage were in negative equity at the end of the third quarter of 2011. This is down slightly from 10.9 million properties, or 22.5 percent, in the second quarter. An additional 2.4 million borrowers had less than 5 percent equity, referred to as near-negative equity, in the third quarter. Together, negative equity and near-negative equity mortgages accounted for 27.1 percent of all residential properties with a mortgage nationwide in the third quarter, down from 27.5 in the previous quarter.
• British Prime Minister Cameron reported slower GDP growth in the U.K. and the need for more austerity.  He expects the U.K. will be hurt by a potential breakup of the eurozone.
• S&P reduced the long term credit ratings of BofA, Citi, and Goldman Sachs from A to A-.  It lowered the ratings of Chase from A+ to A.  Wells and Bank of New York Mellon fell from AA- to A+    Many European banks were also downgraded.
• ADP estimates U.S. employers added 206,000 jobs in November, up from 130,000 in October.
• On Nov. 30 the central banks of the U.S., the euro region, Canada, the U.K., Japan and Switzerland agreed to cut the cost of providing dollar funding via swap arrangements (by 50 bp), the Federal Reserve said, and agreed to make other currencies available as needed.   Essentially the Fed is lending to six other central banks at a fixed rate of exchange for a short period of time until the crisis is over.  China said earlier today it will cut the reserve requirement ratio for banks by 0.5 percentage point from Dec. 5, while data on U.S. business activity and the employment and housing markets topped economists’ estimates. This easing up of liquidity sent stock markets around the world up.  The DJIA rose 3.6% on Nov. 30.  It is now up to the individual European Central Banks, the ECB, and the IMF to see if they will bail out the eurozone.

• Barney Frank announced he will not seek reelection in 2012. He is the Senior Democrat on the House Financial Services Committee and co-author of the Dodd Frank Act.  He may be replaced by Maxine Waters, the next most senior Democratic member.

 

• New home sales in October were at a 307,000 seasonally adjusted annual rate, up slightly from the revised 303,000 level in September but down from the initially reported 310,000 level and lower than what economists expected.  In either case, home sales have been at a floor for the past two years at around the 310,000 level.  They were 323,000 in 2010 and are projected to be 301,000 in 2011, the lowest level ever since records began in 1963.  From 1995 to 2000 sales averaged around 850,000 per year and reached a peak of 1.4 million in 2005.  The only positive signs in the numbers were the median price rose 4% year of year and inventories retreated to 6.3 months from 6.4 months in September.

 

• The seasonally adjusted delinquency rate for mortgage loans on one-to-four-unit residential properties fell to 7.99% in the third quarter of 2011, according to data from the Mortgage Bankers Association’s (MBA) National Delinquency Survey.  This is the lowest level recorded since the fourth quarter of 2008.  However, foreclosure rates and serious delinquency rates remain high.  The percentage of loans on which foreclosure actions were started during the third quarter was 1.08%, up 12 basis points from last quarter and down 26 basis points from one year ago. The percentage of loans in the foreclosure process at the end of the third quarter was 4.43%, unchanged from the second quarter and four basis points higher than one year ago.

 

NEGATIVE TRENDS

 

• According to the Case Shiller housing index, seasonally adjusted home prices fell 0.6% in September from the month earlier.  Of the 20 cities reported, prices were down in 15 cities and up in 5 cities–Washington, DC, New York, Cleveland, Portland, and Dallas.  Prices were down 32.5% from the peak in April 2006.  They were down 3.6% from a year ago.  Using the seasonally unadjusted data, prices were also down 0.6% from the month earlier, down 3.6% from a year ago, and were down 31.3% from the cyclical peak in July 2006.  Prices were down in 17 cities and up in only three cities—Washington DC, New York, and Portland.  Home prices are coming down again after a five month run of increases that occurred during the summer.  More declines are expected in the near term as banks unload more foreclosures.

 

• Initial claims for unemployment rose a bit in the week ending Nov. 26 to 402,000, up from 396,000 in the prior week.  Continuing claims rose to 3,740,000 for the week ending Nov. 19, up from 3,705,000 the prior week.  This is worse than expected and shows weakness in the employment sector.  The four week moving average rose to 396,000 last week, up from 395,000 the prior week.  Similarly, the four week moving average for continuing claims rose modestly suggesting no change in the unemployment rate.

 

• FHA’s capital reserves are 0.24%.  This suggests huge risk to taxpayers since the statutory minimum is 2%.  Since home prices are still plummeting and the unemployment rate is high, there is huge risk for those FHA borrowers with less than a 5% down payment.

 

• From mid-August this year to now, bank volatility has been over 3%; that is, the standard deviation of the daily returns on an index of bank stocks computed using a 30-day rolling window.   Since the great depression, such high volatility has been associated with looming crises.  Currently, such volatility is occurring on all sizes of banks.  In 1930 this measure reached 9%.  In 1937 it reached 4%.  In 1987 it reached 5%.  In 2007 it reached 8%.  It is currently around 4%.  In most years it has been around 1%.  This high volatility suggests that banks are too highly leveraged and investors are fearful for the soundness of the banks.

 

• S&P downgraded Belgium’s debt one notch.  S&P cites a slowing economy and protracted political uncertainty.  Belgium has been without a federal government since elections in June 2010.  S&P projects general government debt at around 93% of GDP in net terms and 97% of GDP in gross terms.

 

• Fitch downgraded the U.S. rating outlook to negative on Nov. 28 following similar downgrades by Moody’s and S&P.  Fitch’s outlook on the U.S., which it still assigns its top AAA grade, reflects “declining confidence that timely fiscal measures necessary to place U.S. public finances on a sustainable path will be forthcoming,” making the probability of a downgrade greater than 50 percent over two years, the company said yesterday in a statement. Standard & Poor’s and Moody’s Investors Service said Nov. 21 that the so-called supercommittee’s inability to reach an agreement didn’t merit downgrades because the inaction will trigger $1.2 trillion in automatic spending cuts.

 

• Italian Prime Minister Monti wrote a letter to Merkel and Sarkozy stating that Italy may default on its debt and their economy crash if Italy were unable to service its debt. The country’s two-year borrowing costs have doubled since early September. The European Financial Stability Facility, the region’s bailout fund, doesn’t have the resources to stand behind Italy’s government debt of 1.9 trillion euros ($2.54 trillion) — much of which comes due next year — and is unlikely to win the support of national parliaments for more funding. So a default would mean a collapse and would be anything but orderly.   Monti said Sarkozy and Merkel “confirmed their support for Italy, saying that they are aware that the collapse of Italy would inevitably lead to the end of the euro.”

 

• New data revealed by the Federal Reserve shows that major U.S. banks were bailed out massively during the financial crisis that started in 2007.  Add up guarantees and lending limits, and the Fed had committed $7.77 trillion as of March 2009 to rescuing the financial system, more than half the value of everything produced in the U.S. that year.  The Federal government claims it didn’t lose any money from the loans but the vast extent of the bailout shows how weak the entire banking structure was at the time.  It is much stronger now but still in trouble as evidenced by the low stock prices for banks today.  The big question is how well they will survive the shock about to come from Europe as the eurozone fragments.

 

• The Economist magazine says “there is little doubt the eurozone will see a deep recession in 2012 with a fall in output of perhaps 2%.  The Financial Times, Bloomberg, and the Economist believe a breakup of the eurozone is imminent.  “Without a dramatic change of heart by the ECB and by European leaders, the single currency could break up within weeks. Any number of events, from the failure of a big bank to the collapse of a government to more dud bond auctions, could cause its demise. In the last week of January, Italy must refinance more than €30 billion ($40 billion) of bonds. If the markets balk, and the ECB refuses to blink, the world’s third-biggest sovereign borrower could be pushed into default.”

 

• The OECD said the eurozone is currently in recession which will continue in 1Q12.  It called the curozone debt crisis “the key risk to the world economy” that could “massively escalate economic disruption” if it isn’t resolved.  An economist at Capital Economics (a consulting firm) predicted eurozone GDP would fall 1% in 2012 and 2.5% in 2013. 

 

• Interest rates charged for eurozone debt continued to escalate at the Nov. 26 auction.  Italy’s 15 year inflation-indexed bond went for 7.3%.  Investors have been punishing banks holding big portfolios of debt issued by the south European nations.  There is fear that as these countries pressure their banks to hold their debt, it could come at the expense of loans to the private sector and cause their economy to go down.  Europe won’t solve its debt problem without improving its economy.  The only way that will occur is likely to be devaluation and increasing exports.  On Nov. 29 the rate for Italian ten-year bonds rose to 7.89%, a new high.

 

• The Commodity Futures Trading Commission reports that investors are betting against the euro.  Morgan Stanley expects the euro to fall to $1.25 by the end of 1Q12.

 

• The U.K. budget office cut its growth forecast for 2011 to 0.9% from 1.7% earlier, and to 0.7% in 2012 from 2.5% earlier.  This means the U.K. must borrow an additional $172 billion over the next five years.  The U.K. would only narrowly avoid recession but is dependent on how deep the eurozone recession is.

 

• Data from U.S. bank regulators showed a decline of 2.5% in employment by 2,500 smaller U.S. banks in 3Q11.  Overall, banks grew by 5,012 jobs to a total of 2.1 million workers.

 

• The yield on the ten year Treasury rose from 1.97% last week to 2.03% this week reflecting strength in the economy.

 

CONCLUSION

 

The good news is little evidence so far in the U.S. that European problems will further weaken our economy; however there is much speculation that the euro will weaken and thereby reduce our capacity to export.  About half the profits of major American corporations come from Europe so a recession in Europe will be reflected in their earnings and thus impact our stock market.  The collapse of the eurozone will cause sovereign debts to be written off and hurt investors in the U.S.

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.

David Olson and Christine Clifford

FOCUS ISSUE FOR THE WEEK

 Bad news from Europe and China dominated the week.  We are no longer merely concerned about the Greeks defaulting on their debt or even the 50% write-down of their sovereign debt.  We are concerned about the debt of all eurozone countries, even Germany.  Can any part of the eurozone hang together?  Will the euro survive in any fashion?

 

The major remedy recommended for saving the eurozone is a fiscal union of all 17 countries but that would require creating new treaties that member countries have been very slow to approve in the past.  With all countries now under threat, would the stronger countries in the north be confident enough to not be dragged down by the weaker southern countries?  It now is evident that all of Europe will have to engage in austerity measures.

 

Adding to the negative news was the reduced estimate for U.S. GDP from 3Q11, the sharp decline in China’s manufacturing sector in November, and the collapse of the Congressional super committee with no agreement on how to reduce our own deficit.

 

What does this mean for the U.S.?  Lower demand for U.S. products, low interest rates, flight to quality of world investable funds, a falling stock market, and the U.S. housing market takes several more years to recover.  Americans have to get serious about holding their leadership position by increased willingness to study longer hours on technical subjects and decreasing time spent on frivolous pursuits; therefore the necessity to train for the available skilled jobs here.

 

MORTGAGE MARKET SUMMARY

Mortgage applications fell 1.2% during the week ending Nov. 19 after falling 10% the prior week even though interest rates remained low.  According to Freddie Mac, the national average commitment rate for a 30-year, conventional, fixed-rate mortgage fell to a record low 4.07 percent in October from 4.11 percent in September; the rate was 4.23 percent in October 2010.

According to NAR, contract failures jumped to 33% in October from 18% in September and were only 8% are year ago.  NAR defines contract failures as “cancellations caused by declined mortgage applications, failures in loan underwriting from appraised values coming in below the negotiated price, or other problems including home inspections and employment losses.” The NAR’s economist, Yun also blames “disruption in the National Flood Insurance Program, and lower loan limits for conventional mortgages” for increased contract failures.

There is little evidence of a housing recovery although existing home sales inched up a bit.  Much of the recovery is in the multifamily sector as rental vacancies decline.  Declining rental vacancies are impacting trends in the single family market as well.  The Campbell Report says that investor purchases of single family homes represented about 22% of closed transactions for the month of October, the third straight month that investors have held a share greater than 20%.  The gap between the supply of distressed properties and their absorption by first-time homebuyers has now widened to 13.7 points in October compared to 8.8 points in September, indicating that first-time homebuyers have become less active in the distressed property housing market.

The DJIA fell from 11,796 last week to 11,231.  The stock market fell 7 days in a row due to the mounting European crisis and lack of solution in Congress to the U.S. debt crisis.  For the week there were 10 positive trends offset by 18 negative trends.

POSITIVE TRENDS

 

• On November 18 the ECB purchased sovereign debt from Italy, Ireland Spain, Portugal, and Greece and brought down the rates for that debt.  As of last week, the ECB held €187 billion of sovereign bonds.  ECB president Mario Draghi said European governments should stop delaying promised anti-crisis measures.  He resists large-scale bond buys and rejects delays in implementing hard measures.  The ECB lacks a mechanism for enforcing fiscal discipline.

 

• There was a new election in Spain and Popular Party, the conservative party, defeated the Socialists by promising austerity to solve the economic problems.  With an unemployment rate of 21%, Spain has a huge challenge to face.

 

• Existing home sales inched up to a 4.97 million annual rate in October from 4.90 million in September.  This was higher than forecast by a survey of economists.  The inventory fell to 8 months from 8.3 months in September and the median price fell 4.7% from a year earlier.

 

• The index of national economic activity produced by the Chicago Fed rose to -0.13 in October from -0.20 in September.  Zero indicates growth at its historical trend rate so we are rising back to trend.

 

• Worldwide investors are being driven into U.S. Treasury bonds by the worsening European debt crisis.  Indirect bidders at the Nov. 14 auction in the U.S. reflect foreign interest.  They fueled much of the demand in the auction.

 

• Toll Brothers bought CamWest Development, a Seattle builder for cash.  Toll has weathered the slump better than its peers.  Since the downturn, the only major deal has been Pulte’s $1.3 billion acquisition of Centex in 2009.  CamWest holds a lot of developable land in Seattle, a hot market when land is scarce.

 

• U.S. auto sales were at a 13.26 million seasonally adjusted annual rate in October, up from 13.1 million in September.  Sales were up 7.5% year over year.  Year-to-date 2011 from 2010, sales were up 10.1%.  Sales are still at depression levels but are rising.  There are more autos being scrapped than sold.  The auto industry is adding jobs and each position has a multiplier of 10.  That is, for each new auto industry employee, 9 jobs are added in Michigan outside the industry.  Since 2008, the Michigan economy has fared better in terms of job and income growth than any other state except oil and gas rich North Dakota.

 

• Payrolls increased in 39 states in October, while the jobless rate dropped in 36, indicating the labor market is steadying across much of the U.S.   Illinois led the nation with a net gain of 30,000 jobs, followed by California with an increase of 25,700 jobs, according to figures from the Labor Department.   Virginia, Pennsylvania and Washington rounded out the top five states with the biggest gains.

 

• The leaders of Germany, France, and Italy agreed on Nov. 24 to pursue closer political and economic integration to shore up Europe’s banks and keep the protracted debt crisis from freezing new lending.  The European Commission presented a proposal that would give Brussels increased powers to monitor the budget of member’s states.  They also pushed for the creation of eurozone bonds that would pool the debt of eurozone countries.  In the past it has taken years to amend their treaty.  Can these countries move fast enough to solve the current crisis and bond rates across Europe soar?  This week even the interest rate on Germany debt rose questioning whether any part of the eurozone will be able to remain together.

 

• The evolution of fracking natural gas from shale in the U.S. has cut the cost of production of a new gas well by one-half to one-third.   This has helped our share of oil consumption met by imports to fall from 60% in 2005 to 47% in 2010.  This is completely transforming the energy security of the U.S.

 

NEGATIVE TRENDS

• The Congressional super committee admitted failure of its mission on Nov. 21 to reduce the federal deficit by $1.2 trillion.  Now that cut will be done across the board unless Congress prevents that from occurring,   Normally this failure should lead to a down grade for our debt but the greater problem occurring in Europe is causing investment funds to stream to the U.S.
• Initial claims for unemployment moved back up a small amount to 393,000 for the week ending Nov. 18, up from 391,000 the prior week.  Continuing claims for unemployment rose to 3,691,000, up from 3,623,000 the earlier week.
• Interest rates on sovereign debt continued to rise this week.  Spain had to pay a record 5.11% yield on three-month bills, more than double the rate it paid last month.  Banks borrowing from the ECB soared to the highest level since 2009 reaching €247 billion in seven-day financing to banks.  Italian ten year bond yields were 6.75%.  Deposits flowed out of southern European banks, especially from Italy, France and Spain.  This forced these banks to increase the interest rates they paid.  In third quarter, bank deposits flowed from banks in south Europe to the Nordic countries, Austria, and Benelux (Belgium Netherlands and Luxembourg).  Nonretail deposits fell 16% and 10% respectively at the Italian banks, Intesa Sanpaolo and UniCredit.  In all of Spain, nonretail deposits fell 20%.  But in the Nordic banks, nonretail deposits rose 7% in third quarter.  As deposits flow out of the south, there will be less money to lend to their corporations and will lead to a credit crunch on top of the austerity measures being imposed.

• CoreLogic says it could take until 2020 for markets to fully digest an overhang of foreclosed properties that represents a shadow inventory of potential bank-owned homes.

• Companies less than a year old employed 2.5 million people as of March 2011, down from 3.5 million in 2007.  Funding remains difficult for new companies.

 

• Merrill Lynch economists expect home prices to drop another 8% nationwide over the next 18 months before bottoming.  They expect the foreclosure process to speed up driving prices down further.

 

• The global financial-services industry eliminated more than 200,000 jobs this year, eclipsing 174,000 in 2009, data compiled by Bloomberg show.

• The second estimate of 3Q11 GDP was 2%, not 2.5% as indicated in the first estimate.  The GDP deflator remained unchanged at 2.5%.  
• Bank of America Corp. dropped the most in the Dow Jones Industrial Average and touched levels last seen in March 2009 as investors speculated on how much faulty mortgages will cost the lender.  Bank of America fell 5 percent on Nov. 21 to $5.49, the lowest since March 11, 2009.  The shares are down 59 percent this year, the worst showing in the 24-company KBW Bank Index. (BKX).  The KBW bank index of 24 large bank stocks peaked at $120/share in 2007 and fell to $36.40 on Nov. 21, down 69% from the peak.  Its lowest level since 2007 was $20 in March 2008.    
• Durable goods orders fell 0.7% in October after declining 1.5% in September.  Most of the decline was from transportation.
• Personal spending rose 0.1% in October after rising 0.7% in September.  This was lower than expected and indicates slow growth.
• The Fed released their stress tests for large U.S. banks (The 2012 Comprehensive Capital Analysis and Review).  Morgan Stanley thinks all the U.S. banks will pass the test but BAC will have the most difficulty due to their bottom tier capital ratios and high mortgage exposure. 
• The euro dropped to $1.32 this week from $1.35 last week and a high this year of $1.49 which occurred in April.  Some forecasters see the euro falling to $1.25 within the next six months.  The low for 2011 was $1.29 in January.
• An auction for German debt fell short by 35% even though the spread offered for the debt was at a two and a half year record spread over comparable U.S. Treasuries.  At the same time the yield on the Treasuries was at a record low yield for Treasury five year debt.  This means that funds are flowing to the U.S. from Europe.  Even German debt is being hurt by the debt crisis in Europe.
• The city of Harrisburg, PA filed for bankruptcy but a judge through out the filing because it was only supported by the city council and not the mayor and other parts of the city government.  A receiver has been appointed for the city placing the city under the jurisdiction of the state.  Many more cities will likely be filing for bankruptcy as well as several states.  This is adding confusion and volatility to the bond market.  Spreads are widening as the risk increases.
• China’s manufacturing sector fell sharply in November, the biggest drop in nearly three years.  This was due to the slowdown in demand from Europe and the U.S.  It caused Asian stock prices to fall more than 2%.
• On Thanksgiving Day, Fitch downgraded Portugal’s debt two points to junk status.  Fitch said a prolonged economic contraction is exacerbating efforts to cure a wide budget gap.  Portugal’s ten-year bond yield rose 43 basis points to 12.64% right after the downgrading.  On Nov. 25 Moody’s downgraded Hungary’s debt to junk status.
• The Italian Treasury paid 6.504% to auction €8 billion of six month loans, almost twice the 3.535% a month ago and the highest since August 1997.  Italy’s two-year bonds yielded a euro-era record 7.83%, almost 50 basis points more than 10-year notes. 

CONCLUSION

Europe is poised for a double dip and if the eurozone fragments, this will slow down the entire world economy.

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.

 

David Olson and Christine Clifford

FOCUS ISSUE FOR THE WEEK

 

The dominant financial news of the week continued to be the turmoil in Europe.  Even though Greece and Italy successfully replaced their prime ministers with technocrats, the cost of their debt continued to remain high and more alarmingly, the cost of debt rose across Europe as Asian investors pulled out of the market.  There were fears that contagion of the debt crisis would spread to the U.S.  At the same time the Congressional Super Committee didn’t come to any resolution of the U.S. debt crisis.  Otherwise, there was more positive news this week than last week as initial unemployment rates fell, industrial production and retail sales rose, inflation was negative, and housing was somewhat improved.  But the stock market and interest rates declined.

 

MORTGAGE MARKET SUMMARY

 

To date the impact of the crisis in Europe has been beneficial to the housing market in America.   The flight to quality in the US has helped keep our interest rates down to historically low levels.  Falling interest rates in the US improve the affordability rate of housing which was already at a historically affordable rate.  According to the National Association of Home Builders/Wells Fargo Housing Opportunity Index  (HOI) data released on November 17^th, “nationwide housing affordability during the third quarter of 2011 hovered near its highest level in the more than 20 years it has been measured. The HOI indicated that a near-record 72.9 percent of all new and existing homes sold in the third quarter of the year were affordable to families earning the national median income of $64,200. The affordability measure rose slightly from the 72.6 percent set last quarter and has remained above the 70 percent threshold for 11 consecutive quarters. The HOI rarely rose above 60 percent prior to this period.”  It is not clear how long the crisis in Europe will have a beneficial impact on housing.  As European banks begin to sell loans to raise cash, it will reduce demand for mortgage backed securities and we could see mortgage rates rise.

 

The position of the American consumer continues to improve.  The four week moving average of unemployment claims continued to decline.  Bankruptcy rates continue to fall.  Although average income in America has not improved, payment –to- income ratios continue to improve, due to high levels of debt restructuring by bankers and refinancing by Americans.

 

Despite improving economics in the US and low rates, mortgage applications decreased 10.0% from one week earlier, according to data from the Mortgage Bankers Association’s Mortgage Applications Survey for the week ending November 11, 2011.

The rules for HARP 2.0 were released this week and servicers are preparing to refinance more of their customers.  Estimates of the number of homeowners likely to refinance under HARP 2.0 ranged from between 800,000 from FHFA to over 5 million from DataQuick.  Approximately 900,000 people refinanced under HARP 1.0.  The expansion of HARP and the continued challenges in Europe will help more consumers refinance their mortgages to historically low rates and thus continue the trend of improvements in American consumers’ finances.  Ballooning of consumer debt both of mortgages and credit cards built up for more than a decade.  It will take some time for savings rates to rebound to the point where consumers feel comfortable spending freely again.  The trends are going in the right direction and deferred demand for housing is building.

The DJIA fell to 11,796 this week, down from 12,153 due to the European banking crisis.  For the week there were 20 positive trends offset by 23 negative trends.

 

POSITIVE TRENDS

 

• Initial claims for unemployment for the week ending Nov. 12 fell to 388,000, down from 393,000 the prior week.  This was better than expected.  Continuing claims for the week ending Nov. 5 fell to 3,608,000, down from 3,665,000 which was also better than expected.  This is a seven month low.

 

• Industrial production rose 0.7% in October after declining -0.1% in September.  This was stronger than expected.  Capacity utilization also rose 77.8% in October, up from 77.3% in September.

 

• Retail sales rose 0.5% in October, after rising 1.1% in September.  This was higher than expected. 

 

• The CPI fell -0.1% in October after rising 0.3% in September in parallel fashion to the PPI.  This was the first decline in four months.

 

• The PPI fell -0.3% in October after rising 0.8% in September.  The core PPI was zero.  There is no inflationary pressure at the wholesale level.  A decline in energy prices caused the decline.

 

• Greeks overwhelmingly welcomed the appointment of Papademos as prime minister.  He won the approval of three-quarters of the population in three separate polls.  Papademos will present his policy agenda to the Greek Parliament on Nov. 14 and have a confidence vote on Nov. 16.  He has the task of implementing the €130 billion bailout before the next election.

 

• Europe now has the task of creating a stronger bailout fund with a capacity of several trillion euros and a massive program of government-debt purchasing by the ECB.  This big question is whether there is sufficient unity to form a fiscal union among the 17 countries.  We don’t think Europe is quite ready for such a task for all the current 17 countries but maybe for the majority of them.  The ECB this year departed from its initial mandate to maintain price stability to buy sovereign bonds to keep the eurozone together.  So far there is little evidence that this policy has worked.  Interest rates on sovereign debt have been climbing relentlessly.

 

• German Chancellor Angela Merkel called for an overhaul of the European Union, advocating closer political ties and tighter budget rules, to end the debt crisis.  However, she did not advocate the creation of a Euro bond.

 

• German Chancellor Angela Merkel’s Christian Democratic Union party voted to offer euro states a “voluntary” means of leaving the currency area.

 

• The Fed is hinting of doing a third round of quantitative easing (QE3) to support the mortgage market.  The Fed already has bought more than $2 trillion of government bonds and mortgage securities.  The New York Fed is requesting that it increase its buying.

 

• Japan’s GDP rose 6% in 3Q11 at an annual rate.  In the prior three quarters it has contracted.  However, a strong yen and slowing global economy could cut into future growth.

 

• The German Christian Democratic Party called for changes to the Lisbon treaty to allow any eurozone members to voluntarily leave the eurozone without leaving the European Union.  Earlier Merkel and Sarkozy made clear that the only way for Greece to leave the eurozone is to rescind EU membership.  Now a compromise might be reached.  Some experts believe states like Greece may have a better chance dealing with their debt problems outside the eurozone.

 

• The House Financial Services Committee approved a measure that would put employees of the Fannie and Freddie on the federal pay scale, effectively cutting the pay of thousands of employees and suspending packages for top executives that can run to millions of dollars.  This shows how far out of favor the two agencies have fallen.

 

• The NAHB home builder index rose to 20 in November, up from 17 in October showing some strengthening in the residential home building industry.

 

• Impac Mortgage Holdings reported third quarter 2011 net earnings of $3.1 million, up from less than $1 million of earnings for the third quarter of 2010. During the third quarter of 2011, the Company continued to expand its mortgage lending activities increasing loan originations and loan sales.

 

• Building permits rose to 658,000 in October, up from 589,000 in September.  This was stronger than expected.

 

• The yield on ten-year debt fell from 2.045% last week to 2.01% this week.  The recent lowest rate ever was 1.68% last September.  The yield on the 30 YFRM rose slightly to 4.00% from 3.99% last week.  The lowest ever was 3.94% several weeks ago.  Analysts believe if investors didn’t think there was a recession coming in the U.S., ten-year yields would be 75 bp higher.

 

• The seasonally adjusted delinquency rate for mortgage loans on one-to-four-unit residential properties fell to 7.99% in the third quarter of 2011, according to data from the Mortgage Bankers Association. This is the lowest level recorded since the fourth quarter of 2008.  The third quarter seasonally adjusted rate of 7.99% is a decrease of 45 basis points from the second quarter of 2011, and a decrease of 114 basis points from one year ago.

 

• The Philadelphia Fed Index slowed to 3.6 in November, down from 8.7 in October.  This shows manufacturing volume in that district of the country slowing down.  An index number of zero means no growth at all.   However, on the positive side manufacturers expect a big increase in demand six months in the future.

 

• Leading indicators rose 0.9% in October, up from 0.1% in September.

 

NEGATIVE TRENDS

 

• The dollar cost of the euro fell to $1.35 this week down from a peak of $1.49 in April but still up from $1.29 in January.  Over the past year is has averaged $1.42.  Over the past five years it has averaged about $1.38 with a high of $1.60 and a low of $1.20.  Some commentators believe the euro will decline to $1.25 within six months.  That assumes the current banking crisis worsens.  This exchange ratio will give clues how successful the bailout is going.  At present the risk of a recession is judged at 50%.  A recession would cause the currency value to decline.  On Nov. 9, the cost of Italian ten year debt rose over 7% but then declined to 6.5% on Nov. 11.  To a large extent, the success of Italian economy can be judged by this measure.   PIMCO’s Bill Gross and Mohammed El-Erian said the recession could be deep in Europe because there is too much debt and too little growth.

 

• The U.S. banks most at risk to economic problems in the eurozone are Chase, Citigroup, and Bank of America.  This reflects the direct exposure of lending, trading and securities to Greece, Ireland, Italy, Portugal, and Spain but not the indirect exposure to other eurozone banks that might go down due to these problems.  Chase’s gross direct exposure is $27 billion.  The stocks of these large banks fell last week due to these fears.

 

• Stratfor (a political research firm) believes the slowdown occurring in Europe will harm China’s growth model and cause a worldwide recession. 

 

• According to the Economist magazine, “For the euro to survive, Italy must succeed. For Italy to succeed, its squabbling politicians must find unaccustomed reserves of unity and courage. That depends on ordinary Italians being willing to make sacrifices, the ECB backing Italy, and France and Germany standing resolutely behind the euro. It is a dauntingly long list of things to go right.”  The Economist visualizes Europe as being in a situation comparable to that right before World War I.  So many actions must go right for Europe to avoid a financial failure and collapse of the European Union.

 

• The cost of five-year debt for Italy rose to a new high of 6.29%, up from 5.32% in its last auction in October.  The yield on ten-year debt was 6.4%, down from 7.48% a week ago.

 

• Three things must be done in Europe soon:  1) bring down Greek debt to GDP level to 80%; 2) increase the size of the ESF (European Support Fund); 3) recapitalize European banks says analysts at Bank of Tokyo.  They foresee the Euro declining to $1.25 over the next six months.

 

• The odds of a U.S. recession in early 2012 exceed 50% as a result of Europe’s debt crisis, according to researchers at the Federal Reserve Bank of San Francisco.

 

• Eric Chaney, Chief Economist of AXA says the European recession has already started.  A credit crunch is occurring.

 

• European industrial production fell 2% in September from August, the steepest slide since Feb. 2009, reported the European Union’s statistics agency.  This suggests the eurozone will fall back into a fairly deep recession said Ben May, economist at Capital Economics.  Another economist at ING Bank expects eurozone GDP to contract 1.5% in 4Q11, followed by a slight contraction in 1Q12.

 

• “It’s a confidence crisis,” said Elwin de Groot, a senior market economist at Rabobank Nederland in Utrecht, Netherlands. “Investors have no confidence that the euro zone can solve its problems. They will look for the most safe place they can store their money, which is Germany. Everything else is suffering.”  On Nov. 15, Italian ten-year debt rose to 7.07%.  Ten-year Spanish yields climbed 19 basis points to 6.29 percent. The extra yield, or spread, over similar-maturity German bunds surged to a euro-era record 458 basis points from 171 basis points on April 12.

 

• GDP in the eurozone grew at 0.2% in 3Q11 and 1.4% year-on-year.  Deutsche Bank economists are forecasting a full blown recession starting 4Q and continuing into 1Q12.  But this recession will be contained within Europe.  There will be credit tightening and fiscal austerity in Europe but not much contraction in trade.  It doesn’t see a reduction in U.S. growth of 2.5%.

 

 

• On November 15, yields for European sovereign bonds rose for many countries other than those from southern Europe.  Italian yield rose back over 7%, Spanish yield surged to 6.4%, and yields for French, Austrian, Finnish, and Dutch bonds rose.  There was heavy selling from investors in Asia and the Middle East.  Investors are also paying more for protection against debt defaults.  The five-year credit-default swaps of Italy, Spain, France and Belgium all hit records.  Italian default swaps briefly pierced 600 bp for the first time.  This suggests turmoil in the bond market will not be restricted only to a few countries and might last longer until all these countries reduce their debts and increase their economic growth.  This is causing the EU to propose moves toward closer economic integration and request the ECB to buy sovereign debt.  The ECB insists its mandate is limited to fighting inflation.

 

• U.S. banks face a “serious risk” that their creditworthiness will deteriorate if Europe’s debt crisis deepens and spreads beyond the five most-troubled nations, Fitch Ratings said. “Unless the euro zone debt crisis is resolved in a timely and orderly manner, the broad credit outlook for the U.S. banking industry could worsen,” the New York-based rating company said yesterday in a statement. Even as U.S. banks have “manageable” exposure to stressed European markets, “further contagion poses a serious risk,” Fitch said, without explaining what it meant by contagion.

 

• European banks are relying increasingly on loans from the ECB as they can no longer obtain funding from customary market sources.  There is a worldwide sell-off of struggling euro nations’ debt occurring particularly from Asia.  At the end of October, eurozone banks had borrowed a total of nearly €600 billion from the ECB, up from €495 billion at the start of 2011.  Among the biggest borrowers are French and Italian banks.  This has put the ECB’s own balance sheet at risk. To protect itself it recently doubled its capital base.  The unemployment rate in France is rising and its GDP is slowing.  French banks have high amounts of sovereign bonds from Spain, Italy, and Greece.  It may lose its AAA rating which would weaken the European Financial Stability Facility.  The big question is whether a united Europe be governed by northern rules—keep the currency sound and budget balanced—or southern rules—run more deficits and routinely devalue its currency.

 

• The premium France pays over Germany to borrow for 10 years jumped to 200 basis points Nov. 17, the highest since 1990. Yields on Dutch, Finnish and Austrian debt also increased this week. Spain sold 3.56 billion euros ($4.8 billion) of a new 10-year benchmark at an average yield of almost 7 percent, the most since the euro’s creation, as demand for the securities dropped.  Italy paid 7.0% for a ten-year bond and France paid 3.72%.

 

• The annual cost of insuring European corporate debt against default has doubled in the past month over what it cost six months earlier.  European companies are facing higher capital costs as bank lending is curtailed and investors step out of the debt market.

 

• Zerohedge, an American financial blog,  reported on Nov. 18:  “confirming that we have entered a complete US dollar liquidity lock up, and that the global coordinated US dollar swap line rescue operation will be launched any minute: both the US FRA-OIS and the EUR Basis Swap are at multi year extremes. The entire dollar funding market is now at levels not seen since the Lehman collapse and is effectively frozen. Only this time it is much, much worse as never before has the global central bank cadre been assumed and implied to be backstopping the global liquidity cascade.  Ex-out the implied backstop by the monetary authorities, and liquidity is now locked up more than ever in the history of capital markets.”

 

• Morgan Stanley forecasts a €1.5 T to €2.5T in deleveraging by European banks over the next 18 months.  This will lead to credit tightness and very bearish on bank earnings.  There is a danger in contagion in emerging markets where 80% of all world growth is expected in 2012.  By 2012 the euro will fall in value to $1.25/euro.

 

• Housing starts slipped slightly to 628,000 in October, down from a revised 630,000 in September.  This was still stronger than expected.

 

• As of November 15 there had been no resolution of the 12 member Congressional Super Committee to resolve the debt situation.  The report is due by November 23 or that will be an automatic cut across the board in federal spending.

 

• FHA’s loss reserves had fallen so low that there is a 50% chance the agency could run out of money and require a taxpayer bailout next year, according to an independent audit of FHA. As of Sept 30, the reserves were $2.6 billion, down from $4.7 billion last year.  FHA comprises about 32% of the overall mortgage market.

 

• U.S. bank stocks have been falling since mid-October and are much below their levels a year ago, but are still above their lows on October 4.  European banks are down more than 25% over this same period.  In general, the larger the bank, the bigger the percentage decline.

 

• Thomas Hoenig, the former Kansas City Fed president, is likely to be chosen by Congress to be head of FDIC.  Mr. Hoenig is a critic of banks being too big to fail.  He doesn’t agree that capital requirements for banks are too high and might choke economic growth.

 

CONCLUSION

 

Despite some evidence of a strengthening U.S. economy, the weakening of the bond market in Europe suggested a downward blip in the U.S. economy over the next several months as European banks conduct a massive deleveraging and hedging costs rise.

 

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.

David Olson and Christine Clifford

FOCUS ISSUE FOR THE WEEK

The problems in Europe became more serious this week.  Last week the eurozone announced it would permit Greece to leave the zone thus publicly admitting this was now an option that other countries might also follow.  Although Papandreou submitted his resignation as Prime Minister and had been somewhat successful in getting austerity measures passed in Greece, most observers see Greece’s only option is to default on its debt and separate from the zone.  There will be a referendum on this question in Greece.  It would then shift to a devalued drachma.  How exactly this would be accomplished is still to be determined.  At the same time Italy’s problems worsened as its interest rates on its two-year, five-year, and ten-year debt rose to over 7% with a negative yield curve on Nov. 9.  This rate is regarded as too expensive to manage, so it is likely also to default as world investors flee Italy’s debt.  On Nov. 10, the ECB bought up this debt and brought rates down below 7% but how long will they be able to keep this up?  S&P downgraded its credit to A with a negative outlook.  There is no world mechanism large enough to bail out Italy.  Would it be the next country to fragment from Europe?  France was having difficulty maintaining its AAA rating and had to institute more austerity measures.  It is now clear that most of Europe has been living beyond its means over the past several decades.  The political forecaster, the Stratfor Group, sees the most likely outcome as a further fragmentation of the eurozone.  This will be the big story over the next several years.  Already Europe is likely in a recession which can only worsen as fragmentation proceeds.  Europe is on the precipice of a financial collapse unless there is a massive bailout of European banks by the European Central Bank.

 

This means Europe will reduce its imports from the U.S. which will reduce the growth rate of the U.S. although this didn’t show yet in September data.   That suggests little further reduction in the U.S. unemployment rate before the November election.  Both Federal Reserve vice chairman Yellen and chairman Bernanke believe that Europe’s sovereign-debt crisis may damage the weak U.S. economic recovery and the U.S. wouldn’t be able to escape consequences of a “blowup” in Europe.  Meanwhile, Congress is failing to solve its debt crisis.  The collapse of Europe illustrates the importance of solving the U.S. debt crisis.  Massive welfare entitlements must be brought under control.

 

MORTGAGE MARKET SUMMARY

Rate and term refinance volume continues to be the lion’s share of mortgage volume this week and is likely to remain so for at least a couple more quarters given the Obama administration’s plan for HARP 2.0.  Refinance applications were up to 78.6% of total applications, according to the MBA, helped by low interest rates due to problems in Europe.  The number of applications increased by 10% on a seasonally adjusted basis for the third straight week primarily due to an increase in refinances.  With the European turmoil and flight from sovereign debt occurring in Europe, there will likely be further flight of capital to the U.S. and the current refi wave will continue.

Despite record low rates consumers are not choosing to take on more mortgage debt.  Freddie Mac released their refinance report this week showing that the number of people choosing to increase their loan by 5% or more fell to a new low of 18% and cash-in loans increased to 37% from 27% last quarter.

Children are living with their parents longer reducing the potential number of home buyers.  The number of young people aged 25-34 choosing not to live on their own rose from 2010 to 2011 from 14% to 19% of men and 8% to 10% of women according to a recent release from the U.S. Census Bureau.  This is the age group that historically buys their first home.  The average age of first time home buyers is 30 according to NAR.  32% of home sales in September were to first time homebuyers per recent statistics from NAR, unchanged from last month and September last year.  Perhaps the historically high levels of student loan debt are to blame.  Total outstanding student debt is nearing $1 trillion and may for the first time outstrip credit card debt when third-quarter data is released later this month.

If the maximum LTV lenders will permit on HARP 2.0 is increased dramatically and a larger number of people refinance to record low rates, won’t the potential number of future mortgage customers be reduced dramatically?  The industry is going to have to find ways to encourage people to move up.  Perhaps they won’t move up but instead they will put additions on their homes to accommodate their adult children remaining in their homes.

For the week there were 10 positive trends offset by 15 negatives.  Over the past week the DJIA rose from 11,983 to 12,153

Positive Trends

 

• Initial claims for unemployment fell to 390,000 for the week ending Nov. 5, down from 400,000 the prior week.  This was the lowest level in seven months.  The four-week moving average remained at 400,000 but was still down from the prior periods.  Continuing claims fell to 3,615,000 for the week ending October 29, down from 3,707,000 the week earlier.  Both figures were lower than expected and suggest a stronger recovery than earlier foreseen.

 

• Greece’s major political parties on Nov. 6 agreed to form a national unity government that will oversee elections after putting in place a debt-slashing deal.  The new government must push through the loan agreement with the EU and the necessary fiscal and structural overhauls.  Without it, Greece will run out of money by mid-December.  New elections are likely to be held on Feb. 19.  Former ECB VP Lucas Papademos was chosen as interim Prime Minister to lead the new government replacing Papandreou. Greece’s state budget for 2012 must be submitted to Parliament by 2012, the IMF must ratify the payment of a sixth aid tranche on Nov. 21, while payments for the recapitalization of Greece’s banks and other aid under the new loan agreement should kick in from early January to keep the country afloat.  He needs to negotiate an agreed 50% haircut for private holders of Greek debt.  Papandreou announced a national referendum on exiting the eurozone.  The cost of Greek ten-year debt hit a euro-area high of 28.4% recently.

 

• A proposal floated by the Obama administration and Freddie Mac to induce private mortgage investors back into the single-family loan industry likely would need to offer double-digit yields to entice buyers, analysts say.  The approach, which is still in the conceptual study phase, would have Freddie Mac
  and Fannie Mae, the two government-seized mortgage giants, sell single family
  mortgage securitizations of which a small slice — 5% or 10% — would be sold without a government guarantee. Investors buying the subordinated security would be the first to take a loss if mortgages in the package default. To attract these investors, Freddie and Fannie would need to offer a higher yield.

 

• U.S. consumers increased their borrowing in September as consumer credit rose $7.4 billion to $2.452 trillion.  The increases were for car and student loans.  These are areas of increased consumer demand.  Credit card debt continued to decline.

 

• A report by the National Federation of Independent Business shows that small businesses (with fewer than 50 employees) led the U.S. in job growth for the fifth consecutive month.  Large firms (with over 500 employees) are shedding employment.  This data is supported by surveys by ADP.  NFIB says 3% of small employers plan to add employees over the next three months, down from a 2011 high of 5% in August.  According to ADP, over half the job gains recently came from small business and less than half came from medium sized firms.  Confidence among U.S. small companies rose in October for a second month, reflecting less pessimism about the outlook for sales and the economy, the NFIB survey found.

 

• The number of positions waiting to be filled in the U.S. rose in September to the highest level in more than three years, indicating some companies are preparing for an improving economy.  Job openings increased by 225,000 to 3.35 million, the most since August 2008, a month before the collapse of Lehman Brothers Holdings Inc. intensified the financial crisis, Labor Department data showed on Nov. 8.   Hiring advanced by 185,000 to 4.25 million, and firings also climbed.

 

• On Nov 9 the yield on U.S. ten-year debt fell to 1.96% as money streamed out of Europe. At the end of last week the yield was 2.045% down from 2.31% two weeks ago.  The U.S. is becoming a beneficiary of the European debt problems and this may lead to a further refinancing wave for U.S. mortgages.

 

• The export volume of the U.S. to Europe is expected to decline as Europe GDP slows down.  It currently comprises 18% of U.S. exports.  But in September U.S. exports actually rose to $180.3 billion and the trade deficit declined to $43 billion from $44.9 billion the prior quarter.

 

• This year, through October, Ginnie Mae issued $263.3 billion in single-family mortgage securities, compared to Freddie Mac’s $251.5 billion. Fannie Mae, the oldest of the three guarantors, sold $418 billion.  For most of their existence, the government-sponsored mortgage companies Fannie Mae and Freddie Mac have been the nation’s largest backers of residential home loans. Now a distant cousin is challenging their reign.  So far this year, Ginnie Mae, a corporation wholly owned by the government that packages mortgages backed by the Federal Housing Administration and other agencies, has issued more mortgage bonds than Freddie Mac, making it the second-biggest funder of home loans.  Professor Gyourko of Wharton says FHA faces $50 billion in losses in the coming years and has insufficient reserves (only $30 billion) to cover these losses.  But if FHA tightens its underwriting, Fannie and Freddie would increase their losses says Professor Rosen at Berkeley.

 

• The University of Michigan consumer sentiment survey rose to 64.2 in November, up from 60.9 in October.  This is the strongest reading since June.

 

Negative Trends

 

• Europe is at risk of a potentially devastating negative feedback loop.  The eurozone economy is expected to shrink 0.4% in 4Q11 according to Markit.  New factory orders in Germany fell 4.3% in the month of September, with new orders from the eurozone plummeting 12%.  This will make fiscal consolidation much more difficult.  If the eurozone economy tips into recession, the weaker European nations are likely to miss deficit targets by an average of two percentage points of GDP over 2012-14, according to J.P.Morgan Chase.  That could mean the ratio of debt-to-GDP is about 15 percentage points higher than expected by 2014.  Greece’s numbers would look even worse.  And if these countries respond to recession with yet more austerity, the downturn is likely to be even deeper, pushing debt-to-GDP higher.  That, in turn, increases the likelihood they would require further help from Europe’s bailout facilities, transmitting strain to stronger states.  According to Stratfor, a political forecasting service, Europe is “Far from emerging as a unified force, the question will be how divided Europe will become.”  They are seeing some fragmentation of Europe coming.  According to Andrew Bosomworth at PIMCO, we are at a “watershed” moment.  With Italy all but locked out of markets, European officials may have to jettison their short-term firefighting and pick between a smaller, stronger euro zone or a federalist structure with greater cross-border support.

 

• Prime Minister Berlusconi pledged on Nov. 8 to step down as his party failed to get a majority on a routine parliamentary ballot.  He will exit after Parliament approves a budget bill that includes promised welfare spending cuts and changes to Italy’s rigid labor laws.   The Italian Senate approved it on Nov. 10 and sent it to the lower house for approval.  The country faces unprecedented international pressure to take credible steps to shoring up its failing economy.  Now parliament must hold a vote on the austerity and economic-growth measures.  Italian Prime Minister Berlusconi is resigning after serving the past 18 years.  He is accused of not solving the country’s massive debt levels—now 120% of GDP, second only to Greece’s 158%.  Its federal debt is now $2.6 trillion.  The cost of ten year debt rose to 7.29% on Nov. 9 and is over the 7% which is considered to be unmanageable for Italy to pay.  It has been expensive enough for the eurozone to deal with Greece, the weakest of the eurozone members but Italy is much larger and is the second most vulnerable nation within the eurozone.  If a quick solution for Italy is not found, the future of the eurozone is much more questionable.  Berlusconi has not lived up to his many promises to eurozone leaders to reduce the nation’s expenses and raise tax revenue.  Italy must turnover $1 trillion in debt over the next three years.  Mario Monti, a technocrat and former EU commissioner, has been suggested to replace Berlusconi.   He commands respect at home and abroad, and would be a good choice. His task would be far from easy: He would have to win support in Parliament for unpopular tax increases, spending cuts and reforms to pension and employment law.  In Italy, that idea is not unprecedented.  The country went through something similar, albeit less demanding, in the 1990s. It remains a tall order.

 

• It is important that France and Germany retain their AAA rating over the next six months if the credibility of the financial backing within the eurozone is to be maintained.  With the current high volatility of financial markets and economic stagnation, this may be a challenge for France and the viability of the eurozone as it now faces two challenges—Greece and Italy.  French Prime Minister Fillon announced a second austerity package in less than three months as the nation battles to rein in its budget deficit.

 

• BNP Paribas SA and Commerzbank AG are unloading sovereign bonds at a loss, leading European lenders in a government-debt flight that threatens to exacerbate the region’s crisis.  BNP Paribas, France’s biggest bank, booked a loss of 812 million euros ($1 billion) in the past four months from reducing its holdings of European sovereign debt, while Commerzbank took losses as it cut its Greek, Irish, Italian, Portuguese and Spanish bonds by 22 percent to 13 billion euros this year. Banks are selling debt of southern European nations as investors punish companies with large holdings and regulators demand higher reserves to shoulder possible losses. The European Banking Authority is requiring lenders to boost capital by 106 billion euros after marking their government debt to market values. The trend may undermine European leaders’ efforts to lower borrowing costs for countries such as Greece and Italy, while generating larger write-downs and capital shortfalls.

 

• European countries that stayed out of the eurozone are hurting now even though they are not members due to close trade ties with the bloc.  The volume of trade is declining throughout Europe.

 

• Commerzbank swung into a third quarter loss after a large write-down on its Greek sovereign-debt holdings.  It warned that financial turmoil across the eurozone would force it to miss its 2012 profit target.  This is the first sign of a potential credit crunch as European banks scramble to meet new European Union capital requirements.  Also the eurozone’s bailout fund, European Financial Stability Facility, is having difficulty raising €1 trillion as a firewall against the debt crisis since investors want more specifics about how the instrument would be used before committing cash.

 

• The deadline for the budget compromise by the Congressional Supercommittee is November 23 and they are not close yet to an agreement.  They are charged with cutting $1.2 trillion from the budget.  Democrats want higher taxes (especially for the rich).  These are opposed by many Republicans who want major spending cuts, especially entitlements, which in turn are opposed by Democrats.  Lack of an agreement may cause the U.S. credit rating to be reduced.

 

• Ally Financial is considering filing for bankruptcy for its ResCap unit which lost $555 million in the past two quarters. 

 

• Fannie Mae said it would seek $7.8 billion more in U.S. government assistance after posting a net loss of $5.5 billion in the third quarter.  It was the 16^th loss in the past 17 quarters.  The year-ago loss was $1.3 billion.  While mortgage delinquencies have stopped rising, Freddie and Fannie are now selling a large number of properties that they took back through foreclosure and are taking bigger losses on those sales due to falling home prices.

 

• In the last four weeks, as anger over debit card fees festered, more than 650,000 customers signed up for credit unions, according to the Credit Union National Association. The association says that 40,000 additional consumers had signed up on Bank Transfer Day, an initiative on last Saturday to abandon traditional banks organized by people associated with Occupy Wall Street.  The value of those accounts was $80 million.  Another beneficiary of the growing unpopularity of banks is Wal-Mart.  They are expanding a series of financial services to their customers, including debit cards and check cashing.

 

• The Federal Reserve Board has no plans to force big banks to meet Basel III capital requirements early — unless, of course, those institutions want to issue dividends next year.  In early November, Fed Gov. Daniel Tarullo said the central bank would not “pull forward” several deadlines under the new rules.  Before any banks could take comfort in such assurances, however, he added that institutions would have to show they could meet the revised capital targets if they want to issue dividends next year.  Bank stocks are under pressure and asset sales can only benefit a bank so much. As a result, the Fed is clearly eyeing retained earnings as the primary means for banks to reach the Basel III capital thresholds.  Regulators released the names of 29 banks considered globally systemically important banks, or G-SIBs, including eight U.S. institutions: Bank of America Corp., Bank of New York Mellon, Citigroup Inc., Goldman Sachs, JPMorgan Chase & Co., Morgan Stanley, State Street, and Wells Fargo.

 

• Foreclosure sales are moving so slowly in half the states that at the current pace, it will take more than eight years on average to clear the 2.1 million homes in foreclosure or with seriously delinquent mortgages, new research shows.

 

• Home prices fell in nearly 75% of metro areas in the third quarter and the national median price dropped 4.7% from a year earlier reported the National Association of Realtors.  Nationwide, distressed property including foreclosures and homes at risk of foreclosure accounted for 30% of third-quarter transactions, down from 33% in the second quarter.

 

• According to the American Banker, commercial banks have excess deposits that are costing them money.  Dan Geller, an executive vice president at Market Rates Insight in San Anselmo, Calif., estimates that federal deposit insurance is costing banks $1 for every $1,000 in deposits they hold. Banks are also incurring at least $200 in annual overhead costs for each checking account, regardless of whether a balance is $100 or $10,000, he said.  And those costs exclude any interest payment to the customer. The current average interest rate on deposits is 0.57%, which banks have to pay regardless of their need for liquidity, Geller said. At Oct. 31, the excess liquidity deposited at the Fed by banks amounts to $1.5 trillion, earning a rate of 0.25%, Geller said.  Marty Hansen, the president of First State Bank in Fairfax, Okla., concurred, noting that his bank is enduring a 52% loan-to-deposit ratio right now. That’s right. His bank has twice as many deposits as it does loans.  Nationwide, that ratio was 73% at midyear, according to the FDIC’s quarterly banking report. That translates into roughly $8.86 in deposits for every $6.37 in loans on banks’ balance sheets. Those funds have to go somewhere if a bank wants to make any money.  When the financial crisis hit, Congress let banks park money at the Federal Reserve for a paltry 25-basis-point return. Banks have made generous use of this option, which still exists; 72% of all deposit inflows from January to June were moved to the Fed, according to the FDIC. Geller said that, barring a last-minute measure by legislators to extend the Emergency Economic Stabilization Act of 2008, such an opportunity will end on Dec. 31.

 

• European GDP may grow 1.5% this year and 0.5% in 2012, the European Commission said on Nov. 10.  It had earlier projected the 17-nation region to expand 1.6% in 2011 and 1.8% in 2012.  In 2013, the economy may expand 1.3%, the commission said.  The EU can’t exclude the possibility of a “deep and prolonged recession.”

 

CONCLUSION

We see Europe fragmenting into a smaller union which will keep market volatile and weaken world GDP.  It isn’t clear how the U.S. will solve its own debt crisis.  We think the best option is the Bowles-Simpson or Ryan plan.  Romney finally announced his plan which has elements of these earlier plans.

 

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.

 

David Olson

FOCUS ISSUE FOR THE WEEK

This was an eventful week for the European economy as the most recent bailout of Greece started to fragment almost immediately.  Interest rates on the debt of Greece as well as for Spain, Portugal, Italy, and Ireland continued to rise.  A Greek referendum on the bailout was set to take place in January but then was scrapped due to pressure from other eurozone countries.  Papandreou survived a confidence vote, 153 to 145, on November 4.  On November 5, a new government will be formed that may not include him as a candidate.  The G20 did not ratify yet another bailout of Greece nor was a deal made with the IMF to help Greece.  Some commentators see Greece gradually ceding its sovereignty to Germany.  Meanwhile, the first repercussion of the Europe debt crisis hit the U.S. with the massive foreclosure of MF Global.  The world stock markets continued to be volatile and street protests against austerity measures and the weak economy occurred around the world.  On the positive side, October auto sales were up.  The unemployment rate fell to 9.0% even though new payrolls were a disappointing 80,000.

 

MORTGAGE MARKET SUMMARY

The MBA index of mortgage applications rose 0.2% for the week ending October 29.  This is a bit slower than the 4.9% increase the prior week.  Fixed 30-year mortgage rates averaged 4.31 percent, down 2 basis points from 4.33 percent.

 

For the week, the DJIA fell from 12,221 to 11,983.  There were 13 positive trends offset by 21 negative trends.  Six of the negative trends reflect deterioration in Europe.

 

Positive Trends

 

• The U.S. rate of unemployment fell to 9.0% in October, down from 9.1% even though the nonfarm payrolls only were 80,000, and was less than expected.  Payrolls were down from a massively upward revised 158,000 the prior month.  The first estimate of September payrolls was 103,000.  Depending on which analyst you follow, it takes from a 120,000 to a 150,000 increase in payrolls to just keep the unemployment rate constant.  Over the past 12 months, payroll employment has increased by an average of 125,000 per month.  The unemployment rate has remained within a narrow range from 9.0% to 9.2% since April.  Average hourly earnings rose 0.2%, unchanged from September and the average workweek remained unchanged at 34.3 hours.  Overall, the employment picture is still very weak but at least it is not deteriorating.

 

• Federal Reserve officials said the economy has picked up while “significant downside risks” remain, and they refrained from taking any additional steps to ease monetary policy.  They predict the growth rate of GDP in 2012 will be 2.5% to 2.9% and the unemployment rate will decline to 8.6%.  According to Roberto Perli, a former Fed staffer, “the Fed, as of now, does not think it will have to raise rates before the end of 2014.”

 

• Federal Reserve Board Chairman Ben Bernanke signaled on Nov. 2 that the U.S. did not intend to follow the lead of Europeans by calling for large banks to quickly raise more capital.  At a press conference following a two-day Federal Open Market Committee meeting, Bernanke was asked about European plans to require their largest institutions to hold 9% Tier 1 core capital by mid-2012. That is a much faster timeline than the Basel III accord, which would require banks to hold roughly 7% common equity capital by 2019 (not including an additional capital surcharge on the largest banks).  The Fed chairman has previously testified that U.S.’ banks exposure to debt-ridden countries such as Greece, Ireland and Portugal has been “quite minimal” so far.

 

• Total auto and light truck sales were 1,021,313 in October, up 7.5% from a year ago.  Year-to-date, sales were up 10.1% from a year earlier.  At a seasonally adjusted annual rate, sales were 13.26 million vehicles, the highest rate since last February.

 

• Private mortgage insurance defaults declined last month by 19.6%, according to the Mortgage Insurance Companies of America’s (MICA) monthly report.  Private mortgage insurance companies reported September defaults fell to 38,719 from 48,187 the previous month.  New business is down 29%:  private mortgage insurers represented by MICA wrote $4.9 billion in new business September, down 29% from $6.9 billion the same month a year ago. The group (which includes MGIC, Radian, RMIC, PMI, and Genworth) had $477 billion in primary insurance in force in September. That is down 38% from nearly $773 billion in September 2010.

 

• BB&T will acquire BankAtlantic for approximately a $301 million premium, or 2x book. 

 

• The serious delinquency rate on mortgages backed by Fannie Mae dropped to 4% in September, the lowest level since June 2009.  The rate fell every month since the 5.59% peak in February 2009 except for July when it went unchanged. Fannie said the rate fell 3 basis points from August.

 

• Initial claims for unemployment for the week ending Oct. 29 declined to 397,000, down from 406,000 the prior week.  Continuing claims fell to 3,683,000 for the week ending Oct. 22, down from 3,698,000 the prior week.

 

• Productivity rose 3.1% in 3Q, up from -0.1% in 2Q.  This caused labor costs to fall 2.4% in 3Q.  This means reduced pressure on inflation.

 

• Factory orders rose 0.3% in September, up from 0.1% in August.

 

• Third quarter commercial and multifamily mortgage loan originations came in 98% higher than during the same period last year and 10% higher than the second quarter, according to the Mortgage Bankers Association..

 

• Construction spending rose for the second consecutive month in September but missed analysts’ projections by a narrow margin. Overall, outlays grew 0.2%, inclusive of a 0.9% gain in private residential expenditures led by home-improvement projects and a 0.3% rise in private non-residential spending.  Since mortgage rates are at all time lows and home sales are low, families will likely have to remain in their homes longer and spend more on home improvements.

 

• The rate on the ten year Treasury ended the week at 2.045%, down from 2.31% last week.

 

Negative Trends

 

• On November 1 Prime Minister Papandreou announced that the recent bail out agreement of five days earlier would be put before the Greek voters in a referendum in January and later withdrew the referendum after strong opposition from Germany and France.  They feared the entire deal would unravel.  An opinion poll published on October 29 showed 58.9% of Greeks oppose the euro area’s expanded bailout package and debt write-down.  If the referendum were to fail, it would bring down the Greek government and cut off international funding for Greece.  It could propel Greece out of the eurozone.  The referendum which must be approved by the Greek Parliament could be held December 4.  The wait from now until December 4 opens a month-long period of uncertainty for Greece, Europe, and the global financial markets.  This causes more confusion and uncertainty than ever.  Greece needs to borrow more before Dec. 4 and financial markets are likely to be frozen over this period for lending to Greece.  The European Financial Stability Facility will not make any payments for at least a week.

 

• To add to this uncertainty in Greece, although Papandreou survived a vote of confidence 153 to 145 on November 4, he will form a new coalition government on November 5 in which he may not run.  The G20 did not offer yet more backing to Greece nor did the IMF.  So the future of Greece is still very uncertain.  Greece may still drop out of the eurozone rather than endure ten more years of austerity. For the first time the eurozone stated that if they don’t get Greek voter support for the bailout, Greece can withdraw from the union.  This was the first time such a withdrawal was ever considered as an option.  Prime Minister George Papandreou struggled to hold on to power after Greece’s largest opposition party rebuffed his overtures to form a national unity government, raising the prospect of elections that could delay aid needed to prevent default. Opposition leader Antonis Samaras rejected sharing power with Papandreou and called on the premier to quit. Papandreou, 59, scrapped a referendum on a bailout accord with the European Union to avert a split in his party before a confidence vote scheduled for midnight tonight. “I never excluded any topic from the discussion, not even my own position,” Papandreou told lawmakers in Parliament. “I am not tied to a particular post. I repeat I am not interested in being re-elected but just in saving the country.”   Papandreou’s inability to resolve the political gridlock pushes the country closer to the first default by an EU nation even as his scrapping of the referendum averted potential ejection from the 17-member euro region. European Commission President Jose Barroso said he expected a government of national unity will conclude the EU agreement before Greece runs out of funds.

 

• The cost of Italian ten year debt rose to 6.06% on October 28, up from 5.86% a month ago.  Since Italy has a 120% debt to GDP ratio, this high interest rate is very costly.  It suggests the bail out of Greece voted on October 26 is not altogether positive for Europe.  Back in August, interest on ten-year debt in Italy was below 5.0%.  The cost of Greek ten year debt rose to 31% compared to 2% for comparable German debt.  Italy failed to issue growth boosting measures demanded by European Union authorities ahead of the Group of 20 meeting raising further doubts about the government’s willingness to pass economic reforms.  Italy’s debt is 118.4% of its GDP, the next highest after Greece’s 144.9%.

 

• After an initial bounce, markets demonstrated a lack of confidence in Europe’s resolve to protect solvent governments from the financial malaise afflicting its weakest member nations. At a bond auction Oct. 28, the euro area’s third- largest economy, Italy, had to pay investors a yield of 4.93%– a euro-era high — to take the risk of lending it 3 billion euros ($4.2 billion) for three years.  As outgoing ECB President Jean-Claude Trichet put it in a speech in late October, European authorities need the power “to take direct decisions” on economic policy in countries that fail to keep their finances in order.  It is questionable whether any countries will give European central authorities control over taxes and spending very soon.

 

• Unemployment rose to 10.2% in the eurozone in September from 10.1% in August.  Spain’s rate is 22.6% and is the highest.  The lowest is 3.9% in Austria.  Unemployment is now 16.2 million which is at the highest level since records for the Euro-Zone began in January 1998.  Economic growth is slowing in the eurozone.   GDP is predicted to decline to 0.2% in third quarter.  Consumer confidence recently fell to a near two-year low in October.  Household savings rates are rising.  Activity of purchasing managers declined also in October.  Morgan Stanley predicts a 0.5% GDP growth in 2012.

 

• MF Global filed for bankruptcy protection due to a bad bet it placed on Europe’s debt crisis.  Its debt ratings have been reduced to junk and investors have streamed away from the firm.  It has positions of $6 billion heavily related to sovereign debts of Spain and Italy.   Its president is Jon Corzine, formerly head of Goldman Sachs and governor of New Jersey.   This has the potential of being the first casualty of the looming European crisis.

 

• According to Ed Lazear of Stamford’s Business School the cause of the European crisis is bloated government expenditures relative to their private economies and slow growth.  Unless these excessively large public sectors are lowered to become proportional to their private economies, repeated bail outs of their debts will only give temporary relief.

 

• Although Republicans have accused the Obama Administration of increasing regulations, it is not quite true at least in terms of number of pages.  For the first three years of Obama the Federal Registrar has averaged 77,570 pages per year.  In the second Bush administration the Federal Register averaged 77,896 pages and 75,670 in the first Bush administration or 76,783 pages over the entire eight years.  Probably critics are referring to the comprehensive nature of two acts—the Dodd Frank Act and the ObamaCare Act.  The Dodd Frank is 2,319 pages long, mandates 300 new rules, including 160 regulations, of which 80% remain unfinished.  GAO says it will cost $1.25 billion to enforce this law over the next two years.  The Health Care Law is around 2,000 pages long and includes an estimated 95,000 pages of regs of which most have yet to be written.   That is based on 6 pages of the law translated into 429 pages of regulations so far written according to US. News Politics.  There has also been an iffyness about our regulations lately—will taxes be raised or lowered, will they be temporary or permanent, will Washington help raise home values, will the new health care law be implemented or repealed, will proposed regulations be implemented or repealed?  This has led to a huge amount of uncertainty, which has discouraged investment and kept growth in GDP low.

 

• The world’s two largest refrigerator manufacturers, Whirlpool and Electrolux, announced production cuts due to falling demand for their products.  Consumers are cutting back spending on big-ticket items. North American appliance sales this year will be 25% below their 2005 peak.  Western Europe will be down 15% from their 2006 peak.

 

• The Real Clear Politics average of all health polling puts opposition to the Affordable Care Act (ObamaCare) at 50.6% in October and support at 38.4%.  Support is down from a summer high of 41.5%.  According to the Kaiser poll, support is 34% in October, down from 41% in September.  Opposition is 51%, up from 45% in September.  The biggest slide came from Democratic supports whose share of support fell from 65% in September to 52% in October.

 

• Per capita median household income as of June 2011 was 3% lower than in June 2007 reported the Commerce Department.  Since the recession’s end in June 2009, the economy has not been adding jobs at a fast enough pace—at least 150,000 jobs per month—to absorb the growing population.

 

• The ISM-Chicago index fell to 58.4 in October, down from 60.4 in September.  This indicates a slowing down in manufacturing.  An index of 50 means no growth at all.

 

• The national ISM index in October fell to 50.8, down from 51.6 in September.  This is getting close to 50 which signifies no growth at all in manufacturing.  But the ISM index of new orders did rise a few points which is positive for future growth.

 

• The national ISM-services index in October fell to 52.9, down from 53.0 in September.

 

• Construction rose 0.2% in September which is slower than the 1.6% growth in August.

 

• Bank analyst, Mike Mayo, says the next decade will be the worst for bank stocks since the 1930s.  Margins are getting squeezed.  There will be very slow growth.  In the past decade U.S. banks tried to grow too quickly and took on too much risk.  He said the recent resolution of the Greek crisis was dead on delivery from every aspect.  The Canadian banks have performed better over the past decade because they have less competition.  Of all U.S. banks he likes PNC the best.

 

• The ADP estimate of net new employment was 110,000 jobs in October, down slightly from 116,000 in September.  This indicates a continued lackluster market for employment.

 

• PHH Inc. reported a net loss of $148 million in the third quarter, much worse than last year’s loss of $8 million.

 

• Ally Financial Inc. (Ally) on Nov. 4 reported a net loss of $210 million for the third quarter of 2011, compared to net income of $113 million in the prior quarter and net income of $269 million for the third quarter of 2010.  Core pre-tax income, which reflects income from continuing operations before taxes and original issue discount (OID) amortization expense primarily from bond exchanges, totaled $102 million in the third quarter of 2011, compared to $466 million in the prior quarter and $635 million in the comparable prior year period.  In order to proactively address the changes in the mortgage industry as a whole, the company will take immediate action to reduce its focus on the correspondent mortgage channel. Ally will maintain correspondent relationships with its key customers and will continue to participate in the consumer and broker lending channels, which are higher margin businesses. The correspondent channel represents approximately 84 percent of the company’s mortgage originations year-to-date.  As a result, Ally’s exposure to MSR asset volatility will decrease over time, and the company will be better positioned to comply with Basel III requirements.

 

• The U.S. homeownership rate in the third quarter was at the second-lowest level in 13 years as borrowers were evicted after foreclosures and the tightest mortgage standards in more than a decade thwarted new buyers.  The ownership rate was 66.3%, up from the 13-year low of 65.9% in the prior quarter, the U.S. Census Bureau said in a report on Nov. 2.  It was the only gain in two years.  The vacancy rate, measuring empty properties for sale, was 2.4%, compared with 2.5% in the second quarter, according to the report.

 

• Freddie Mac reported a $4.4 billion loss for the third quarter and said it will seek $6 billion from the U.S. Treasury Department. The request brings Freddie Mac’s total Treasury draw to $72.2 billion although it has returned $14.9 billion of that money to taxpayers in the form of dividend payments to the government (including $1.6 billion in the 3^rd quarter).

 

CONCLUSION

A trimmer Europe may be a less costly solution than expecting the Greeks to endure ten years of austerity and Germany to contribute ever larger sums to bail out southern Europe.  Devaluation would get the pain over more quickly.  The U.S. has so far avoided a double dip recession as bond investors streamed out of Europe to the U.S.  But it is harder to foresee better than mediocre growth for U.S. banks over the next five years.

 

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.

David Olson

FOCUS ISSUE FOR THE WEEK

There are two major cures being proposed for Europe’s debt problems:  1) kick out Greece and the other weaker members of the Euro-Zone and have them deflate their currencies or 2) move towards fiscal federalism.  A spokesperson for Societe Generale forecasts a shift to federalism said that fiscal federalism means structural reform, fiscal austerity, and wage restraint, not a transfer of sovereignty to Germany.  Other commentators such as Michael Lewis see the differences in culture within Europe as too great to get a fiscal union.  There is great fear of German control over their countries.  At present, only Germany has the credit and restrained culture sufficient to bail out Europe.  From my survey conducted two weeks ago, I found Europeans and especially Germans weren’t in a mood to pay for further bailouts for other weaker countries in Europe.  How this crisis works out will be the dominant issue over the next five years.  This week the Euro-Zone managed to delay the solution a few months more.

Meanwhile, the U.S. is dealing with its own debt crisis as it uses austerity to cure its problems.  This is causing prolonged high levels of unemployment and no growth in household income.  Growth in real GDP will at best average 2% over the next ten years according to several commentators and may dip back into a recession if Europe tanks.  The banking system worldwide is hurting and it is hard to see a quick recovery to our economy.  We all have to work harder, upgrade our skills, and do more saving.

MORTGAGE MARKET SUMMARY

The Mortgage Bankers Association’s index of mortgage application activity, which includes both refinancing and home purchase demand, rose 4.9% in the week ended Oct 21.  This was a recovery from the prior week when the index declined 14.9%.  Fixed 30-year mortgage rates averaged 4.33%, unchanged from the previous week.

For the week, the DJIA rose 3.5% from 11,808 to 12,221.   There were 10 positive trends offset by 20 negative trends.

Positive Trends

• Third quarter GDP rose to a 2.5% annual rate, up from 1.3% in second quarter. This is slightly lower than expected but is a great improvement.  There also was an increase in optimism by economists due to an increase in capital good shipments and construction activity.  What happens in 2012 is partly dependent on whether congress will vote to keep last December’s payroll-tax cut in place and renew extensions on unemployment benefits.  The average annual rate of real GDP over the past 40 years has been 2.84%.  Several forecasters are predicting that over the next ten years real GDP will average only 2% as we increase our saving and bring down our excessive debt levels.

• On October 24, Obama announced a new overhaul of the HARP plan to let borrowers whose mortgage are backed by Fannie and Freddie to refinance regardless of how far their homes’ values have fallen. Loans that exceed the current 125% LTV won’t be eligible to refinance until early next year.  The original HARP plan was used by only 894,000 borrowers.  The new overhaul is projected to be used by 500,000 to three million borrowers.  It requires much less data on credit worthiness and job security than in the past.  Borrowers won’t have to refinance with the company that services their loan but may go to any lender.  This amounts to a transfer from savers to borrowers.  The program potentially undermines the creation of a private housing finance market and leaves unsettled the future of Fannie and Freddie.  Critics of the plan charge that without first getting the rate of unemployment down, this new program will not likely reduce mortgage foreclosures much and will cause more harm to mortgage lenders.  Supporters of the plan see this is a last effort by Obama to recover the housing market before the election next November.  Currently lenders are behind in their refi activity and it takes a long time to hire and train new underwriters.  Until the regs are written, it is hard to know how many consumers will actually be served.

• Enhancements to HARP Phase II address several other key aspects of HARP including: eliminating certain risk-based fees for borrowers who refinance into shorter-term mortgages and lowering fees for other borrowers; removing the current 125 percent LTV ceiling for fixed-rate mortgages (FRMs) backed by the GSEs; waiving certain representations and warranties that lenders commit to in making loans owned or guaranteed by the GSEs; eliminating the need for a new property appraisal where there is a reliable automated valuation model (AVM) estimate provided by the GSEs; and extending the end date for HARP until Dec. 31, 2013 for loans originally sold to the GSEs on or before May 31, 2009.  This will reportedly enable about 1,000,000 homeowners to refinance their homes.  If we assume an average loan balance of $200,000, this means a potential origination volume lift of about $200 billion in production. Given the MBA forecast of $900 billion, this program would represent about a 22% potential increase in national volume.  But it still leaves ten million mortgage holders underwater.

• The retail price of a gallon of gasoline in the U.S. fell to $3.46 on October 24, down from $3.97 in early May. Many economists expect gasoline prices to fall further which who help consumer spending.

• New home sales rose to a 313,000 annual rate in September, up from 296,000 in August. This was higher than expected but is still basically flat since 2009.  A normal rate would be 1 million.

• Initial claims for unemployment fell to a 402,000 annual rate for the week ending Oct 22, down from 404,000 the prior week. This shows a very slight improvement.  Continuing claims fell to 3,645,000, down from 3,741,000 which is a big improvement.

• Personal income rose 0.1% in September after falling 0.1% in August. Personal spending rose 0.6% in September from 0.2% in the prior month.

• GDP recovered to pre-recession levels in 3Q11.  However, GDP per capita remains 2.9% below pre-recession levels according to the Commerce Department.

• Ed DeMarco, acting direction of FHFA is under huge pressure to do principal write-downs of mortgages but he is resisting because he doesn’t want to increase taxpayer losses at Fannie and Freddie above the $141 billion current level.

• The final reading of the October University of Michigan Consumer Sentiment Index came in at 60.9, above the 59.4 registered in September and the 57.5 seen in the preliminary reading.  But this is still near the lowest level recorded during the past six years and down from the average of 85 for that period.

Negative Trends

• A report by international inspectors said Greece’s funding needs can only be met if bondholders accept write-downs of 60% or if Euro-Zone governments lend Athens billions of euros more than planned. But instead the European leaders agreed on a 50% haircut by private investors and they agreed to expand the firepower of the European Financial Stability Facility to guarantee €800 billion to €1.3 trillion of bonds which is up from the current level of €440 billion.  Greece received €130 billion in bailout loans.  In combination, that will reduce Greece’s debt from 160% of GDP to 120% by 2020.  There is a risk to the Euro-Zone’s triple-A rates states, mainly Germany and France if they raise this fund.  Harvard professor Rogoff believes investors will have confidence in the EZ only “if they lay out a vision of how it will put itself on track and move toward greater political and fiscal union.”  There is another savior in the wing—the European Central Bank.  But the ECB has no incentive to betray in advance its willingness to get France and Germany off the hook by printing money to keep Europe’s heavily indebted governments afloat.  There are also a series of measures for bank recapitalization.  One requires Euro-Zone banks to achieve a 9% capital ratio for core Tier 1 capital by June 2012. 

• The head economist at Mitsubishi UFJ Securities believe the meeting on Oct 23 over the European Monetary Union was a success. The ECB was taken out of the recovery.  Greece will likely go into default and be taken out of the EMU.  There isn’t enough political will left in Germany to support it.  Portugal will probably be next.  But there is a good chance that Italy and Spain can be saved.  There will likely be a recession in Europe next year.  The open question is what becomes of the largest French banks and their impact on U.S. banks?

• Niall Ferguson of Harvard believes Europe is muddling about and not taking the serious steps to address this crisis. Most European banks are currently insolvent so there will likely be a bank run which will cause at least one major bank to fail within the next six months.  The problem is bigger than just Greece.  Ireland and Portugal are nearly as bad.  In the end, he thinks the ECB will have to print its way out of this problem.

• Fitch issued a statement that, “The 50 percent nominal haircut on the proposed bond exchange would be viewed by the agency as a default event under its Distressed Debt Exchange criteria.” While the accord is “a necessary step to put the Greek sovereign’s public finances on a more sustainable footing,” Greece will face “significant challenges” including ratios of government debt to gross domestic product at “well over 100 percent even in a positive scenario.”

• The Federal Reserve estimates that 37.7% of U.S. money market funds are exposed to European banks as a percent of assets. If the Euro-Zone crashes as expected there probably will be a decline in the U.S. stock markets.

• The risk of recession in the Euro-Zone is mounting. The PMI for the EZ fell nearly two points to 47.2 in October according to Markit.  PMI readings below 50 signal a drop in business activity. Only two major players—Germany and the European Central Bank—have much financial firepower left, and neither is keen on using it.  The Euro Zone is on the cusp of a deep recession said an economist at Capital Economics.  In fourth quarter 2001 GDP is expected to be -1%.  Investors are getting increasingly nervous about Italy driving up its borrowing costs to levels that potentially threaten the country’s solvency.

• Sony Kapoor, managing director of policy group Re-Define Europe, says the agreement reached on Wednesday was significant politically but it is still too little and too late. The Euro-Zone will need more money from the ECB and will need to create a growth strategy which will be difficult since Japan and the U.S. are so weak.

• Americans now owe about $950 billion in student loans — more than their total credit-card debt. Two out of five Americans with federal student debt can’t make monthly payments and either defer, default or are delinquent, according to Mark Kantrowitz, publisher of Fastweb.com, a free scholarship-matching service, and FinAid.org, a source of student financial aid information.  There are very few ways to reduce or renegotiate education debt; unlike credit-card debt, few can do this via bankruptcy.  A provision in the 2010 health-care reform law pushed private lenders out of the business of issuing federally guaranteed loans. The 2010 Dodd-Frank financial reform law puts the new Consumer Financial Protection Board in charge of collecting better data and regulating private student lenders. The new agency also is planning to launch an online tool — a “student debt assistant” — to help debtors learn more about their options.

• The index of consumer confidence by the Conference Board fell to 39.8 in October, down from 46.4 in September.  This was lower than expected and was the lowest level since March 2009.

• The Bloomberg Consumer Comfort Index fell to minus 51.1 in the week ended Oct. 23, the lowest in a month, from minus 48.4 the prior period. Ninety-five percent of those surveyed had a negative opinion about the economy, the worst since April 2009 and one percentage point shy of a record high.

• The FHFA housing index fell -0.1% in August, down from 0.8% in July. This means even prices of Fannie and Freddie mortgage loans fell in value in August without including prices of foreclosed homes.

• The Case Shiller seasonally adjusted index of home prices fell 0.04% in August. There were declines in 14 cities and increases in 6 cities.  The biggest increase was in DC and the biggest decline was in Atlanta month-over-month.  Using the unadjusted data, the index rose 0.15%.  Prices rose in ten cities and fell in 10 cities.  Prices are down 3.8% since a year ago which is more than expected by economists.  Since April 2009, home prices have been basically flat.  Prices recovered 6.9% from April 2009 to July 2010 and then fell 7.6% to March 2011.  They retreated back to where they were in April 2009.  From March 2011 to August 2011 they recovered 3.7%.  As of August 2011, prices were still down 30.8% from their peak in July 2006.  According to CoreLogic, more than 25% of home borrowers are underwater.  That is, their current property value is less than the value of their mortgage.  Due to the large imbalance between supply and demand, home prices are expected to fall further before they reach a true bottom.

• Strong growth of rents and occupancy levels of rental apartments have pushed some building values to record levels as Americans shift away from home ownership.  At the end of September 2011, apartment vacancies fell to 5.6%, down from 5.9% in June.  The U.S. is expected to see 1.5 million rental household formations in 2011 according to Green Street.  At some point this increase in household formations, could be shifted to supporting home purchases.

• Pending home sales reported by the National Association of Realtors fell 4.6% in September, after falling 1.2% in August.

• The latest trends report from CoreLogic shows homeownership rates for the 25 to 34 and 35 to 44 year-old age groups composing the largest number of first time home buyers, was down 10% in 2010 compared to 30 years earlier. The slip in homeownership among first time buyers is apparently because of doubts over the weak economy and declining home prices in most areas of the U.S.

• Arizona regulators have taken over PMI Group. Now the insurer will pay just 50% of claims in cash, and the remainder will be deferred.  PMI had been paying claims of about $1.5 billion a year to reimburse lenders and mortgage investors.

• MGIC Investment reported a wider third-quarter loss as the cost of claims from mortgage delinquencies rose. It dragged the stock price of others, such as Radian and PMI, down. Most believe that capital reserve levels have been depleted at many older MI companies, and MGIC has been unprofitable for 16 of the last 17 quarters.

• Genworth Financial Inc.’s mortgage insurance business will either improve results or cease writing new coverage, according to analysts at CreditSights Inc.  The unit “faces a binary outcome,” Rob Haines and Eric Axon of CreditSights said in a note to clients today. “Either the MI business becomes more viable as recent vintage business offsets deterioration in the older vintages, or the business is placed into run-off. We believe that either outcome would improve market perception of the company’s credit profile.”

• Orders for durable goods fell 0.8% in September after declining 0.1% in August.  Much of the decline was in transportation.  Excluding the transportation sector, there was an increase.

• The Census Bureau reported that fewer Americans moved in 2010 than in any year since World War II due to the housing bust and high unemployment.

CONCLUSION

GDP rose at a 2.5% annual rate in 3Q but there is little hope of a return to the higher levels of the past of closer to 3%.  More likely there will be another bump as Europe struggles to deal with its financial crisis.  Its growing austerity cuts back purchases from the U.S.  Slow growth means continued low interest rates but they can’t get any lower than they are currently.  That means refis will decline in 2012 and originations will be around $1 trillion.  We see opportunities for smaller retail mortgage originators who aren’t encumbered with servicing poorly underwritten loans of the past.  Those firms with skills in compliance will do the best.  But we hear of many smaller commercial banks having to shut down because they can’t afford the cost of compliance.

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