It's A Good Time To Review The Correlation Between Fed Funds And Mortgage Rates

Here is a common question over the past few weeks:

“If rates were cut .500%, is my 30 year fixed going to be .500% lower?”

The answer is different than you may think, and while I do agree that we tend to see declining interest rates in mortgages when the Federal Reserve is in the cut-side of the rate cycle, the subtle relationship between Fed Funds and Mortgage Rates needs to be understood if you are engaged in a purchase or refinance transaction involving money borrowed from a bank. Failure to understand this means you may get caught on the wrong side of a timing bet.

Remember “Fed Funds” is the rate that banks can borrow money from each other to keep their reserve amounts in line. The “Discount Rate” is the interest rate at which an eligible financial institution may borrow funds directly from the Federal Reserve when their reserves dip below the reserve requirement. It's considered the last resort for banks, which usually borrow from each other. The Federal Reserve can change either – but they can’t change mortgage rates!

Check out this chart for an illustration. You'll notice some basic tendencies that are similar, but by no means is there a basis point to basis point connection. In fact, when the Fed cuts rates, there is often a spike in mortgage rates based on the perceived threat of inflation associated with lower borrowing costs at the institutional level. Mortgage rates are based on long term fixed income investment vehicles, aka bond instruments, which hate inflation. Inflation eats away at the value of that income over time.

Looking back at the markets when the Fed threw in a surprise .750% rate cut, I believe it was the news about the rogue trades made by Societe Generale to the tune of MINUS 7.1 BILLION DOLLARS that caused the Fed to throw in the emergency towel and caused domestic money to pile into safe fixed income investments – like mortgage bonds. This pushed mortgage rates down quickly. It was not the Fed action directly causing mortgage rates to improve, but both were reacting to the same news in their own way for different reasons. In the days that followed, the mortgage bonds quickly reversed and went the other direction, suggesting that the Fed action ultimately caused rates to worsen when you look at the net of the 2-7 days that followed the news... Again, lower Fed rates invites inflation, arch enemy of fixed investments.

This does not mean that I expect to see rates rise steadily as the Fed continues this cutting cycle - and I expect to see the Fed go another 100 basis points over the coming year. Mortgage rates will also come under pressure based on the same economic data that the Fed is responding to. The important lesson here is to understand that the Fed is trying to achieve balance between price stability and economic growth. Cutting rates threatens price stability by inviting inflation. But raising rates to fight inflation chokes off growth. This is why they constantly tamper with the Fed Funds rate. The bond market reacts to their policy decisions and jumps back and forth based on how effectively it views the Fed to be at maintaining that balance.

It may not be simple to understand. But if you are in a mortgage transaction, or about to consider one, you best make sure that you're working with a professional who gets this. Waiting to lock because we expect the Fed to cut rates has been bad advice at every single cut since the Fed began easing in this cycle.

Conforming & Jumbo Loan Limts For 2008 - YET EVEN MORE Market Chatter

Possible Impact of Higher Limits

There are 19 metropolitan areas where the economic stimulus package's changes to the conforming loan limits would likely have an impact, according to this analysis from the Stanford Group Company, a Washington, D.C.-based financial services company. Of those, seven are in California and six are in the New York metro area. Stanford uses median home price data from the National Association of Realtors.

Metropolitan Area
Median Home Price(Q3 07)
Median Home Price x 1.25
Proposed New Limit
Increase Above Current Limit

Anaheim-Santa Ana, Calif.
$700,700
$875,875
$729,750
$312,750

Barnstable Town, Mass.
$400,600
$500,750
$500,750
$83,750

Boston-Cambridge-Quincy, Mass.
$414,700
$518,375
$518,375
$101,375

Boulder Colo.
$367,500
$459,375
$459,375
$42,375

Bridgeport-Stamford-Norwalk, Conn.
$491,100
$613,875
$613,875
$196,875

Los Angeles-Long Beach-Santa Ana, Calif.
$588,400
$735,500
$729,750
$312,750

Miami-Fort Lauderdale-Miami Beach, Fla.
$346,800
$433,500
$433,500
$16,500

New York-Northern N.J.-Long Island, N.Y./N.J.
$476,100
$595,125
$595,125
$178,125

New York-Wayne-White Plains, N.Y.
$550,900
$688,625
$688,625
$271,625

Edison, N.J.
$391,800
$489,750
$489,750
$72,750

Nassau-Suffolk, N.Y.
$470,000
$587,500
$587,500
$170,500

Newark-Union, N.J./Pa.
$459,700
$574,625
$574,625
$157,625

Riverside-San Bernardino-Ontario, Calif.
$377,000
$471,250
$471,250
$54,250

Sacramento-Arden-Arcade-Roseville, Calif.
$335,700
$419,625
$419,625
$2,625

San Diego-Carlsbad-San Marcos, Calif.
$589,300
$736,625
$729,750
$312,750

San Francisco-Oakland-Fremont, Calif.
$825,400
$1,031,750
$729,750
$312,750

San Jose-Sunnyvale-Santa Clara, Calif.
$852,500
$1,065,625
$729,750
$312,750

Seattle-Tacoma-Bellevue, Wash.
$394,700
$493,375
$493,375
$76,375

Washington-Arlington-Alexandria Va./Md.
$438,000
$547,500
$547,500
$130,500

Source: NAR, Stanford Group

Conforming & Jumbo Loan Limts For 2008 - EVEN MORE Market Chatter

Yesterday, the US House of Representatives overwhelmingly passed HR 5140 – an economic stimulus package that includes a temporary increase in the conforming loan limit and the upper threshold for FHA loan programs to as much as $729,750 in high-cost areas. The temporary increase would last only until the end of 2008. The bill would also restrict Fannie Mae, Freddie Mac and the Federal Housing Administration from guaranteeing or purchasing loans above 125 percent of the median home price for a given area. That means that the existing $417,000 conforming loan limit for mortgages eligible for purchase by Fannie and Freddie would not increase in areas where the median home price is $333,600 or less. The problem of course, is that as of right now, no one knows what the median home price is in different markets because this data has never been published by HUD!

Therefore, it would be up to the Secretary of Housing and Urban Development to determine the median home price for different housing markets "as soon as practicable," but no later than 30 days after passage of the bill, relying on existing commercial data where needed. In other words, if median home prices in your marketplace are $336,000 or less, this bill won't really affect you; and there's no way to tell if median home prices in your area are higher than $336,000 until HUD publishes this data. Nevertheless, jumbo relief is certainly on the way for places like California where median home prices are certain to be above $336,000.

Currently, the loan limit for FHA loan programs is between $200,160 and $362,790, depending on the county where the property is located. The proposed higher limits for FHA loan guarantees are also set to expire at the end of this year, unless Congress passes other legislation intended to modernize FHA programs by introducing risk-based pricing and lowering down-payment requirements.

While House leaders thought they had reached an agreement with the Bush administration to include FHA modernization as part of the stimulus package, they agreed to continue working on that issue separately at the administration's request, the Associated Press reported.

In order to make higher limits a reality, the next step is for the Senate to pass the bill and for the President to sign it into law. The target date for final passage set by the White House and Congressional leaders is February 15.

Conforming & Jumbo Loan Limts For 2008 - MORE Market Chatter

MBA (1/25/2008 ) Sorohan, Mike
The Bush Administration and the House of Representatives yesterday agreed on a $150 billion economic stimulus package that contained key components supported by the Mortgage Bankers Association.

Specifically, the package calls for Federal Housing Administration loan limits to be increased from $362,000 to as much as $729,750. The government-sponsored enterprise conforming loan limit would increase from $417,000 to a maximum of $729,750. And to provide an incentive for lawmakers to work on overall GSE regulatory reform, the loan limit increases for the GSEs are limited to one year.

MBA Chairman Kieran Quinn, CMB, praised Administration and House leaders for their bipartisan approach and quick action, saying the package will help borrowers and stabilize the housing and mortgage markets.

“This stimulus package will bring much-needed help to consumers and restore some stability to the housing and mortgage markets,” Quinn said. “Reform of the Federal Housing Administration has long been a top MBA priority. A more modern and vigorous FHA will provide another option for first time and low and moderate income borrowers and borrowers who need to refinance existing mortgages.”

Quinn said a temporary increase in Fannie Mae and Freddie Mac's loan limits, as well as a boosting of the FHA loan limit, should return liquidity to a portion of the mortgage market that has essentially been at a standstill since August. “This will be especially helpful to current and potential homeowners in areas of the country that have seen the largest price run ups during the recent boom,” he said. “It is not coincidental that many of these areas are the same ones that are now facing the most difficulty.”

In addition to the housing provisions, the package contains tax rebates of up to $1,200 per family and allows businesses to double the amount they can write off for capital investments.

President Bush said he was pleased by the quick action, asserting that while the economy was “structurally sound,” it is dealing with short-term disruptions in the housing market and the impact of higher energy prices.

“This package has the right set of policies and is the right size,” Bush said. “The incentives in this package will lead to higher consumer spending and increased business investment this year. Importantly, this package recognizes that lowering taxes is a powerful and efficient way to help consumers and businesses. I have always believed that allowing people to keep more of their own money and to use it as they see fit is the best way to help our economy grow.”

Not everyone expressed pleasure with the package. Office of Federal Housing Enterprise Oversight Director James Lockhart III said he was “very disappointed” with the proposed increase in the GSE conforming loan limit, calling it a “mistake to do so in the absence of comprehensive GSE regulatory reform.”

“To restore confidence in the markets we must ensure that the GSEs’ regulator has all the necessary safety and soundness tools,” Lockhart said.

Ideologists on both end of the political spectrum also found fault with the package, saying that it did too much (conservatives) or not enough (liberals). And Senate leaders indicated that they might add provisions that the House/Administration agreement does not have, such as extension of unemployment and food stamp benefits, which they said would provide a quicker jump-start to the economy.

But House Speaker Nancy Pelosi, D-Calif., who conceded that she was not “totally happy” with the package, nonetheless defended it, calling it the result of compromise and cooperation. She said the Bush Administration made key concessions on the scope of the tax rebates, which cap at $174,000 in 2007 family income.

“Our goals were to provide working Americans who are struggling in these difficult economic times with timely, targeted and temporary relief and to quickly give our economy a shot in the arm. We have accomplished both goals,” Pelosi said. “Economists agree that any stimulus package must put money in the hands of those who will spend it quickly to stimulate the economy, and this bipartisan package does just that.”

Pelosi said the package would go to the full House for a vote next week. The bill would then move to the Senate, where Senate Majority Leader Harry Reid, D-Nev., said the goal was to have a bill on President Bush’s desk by Feb. 15. Depending on what bill the Senate passes—and how the House, Senate and Bush Administration agree on a final package—the bill’s provisions could go into effect this summer. Treasury Secretary Henry Paulson Jr. said the first rebate checks could go out as early as May.

“All these provisions should provide a boost for struggling borrowers and the stalled housing market,” Quinn said. “We are pleased to see that leaders on both sides of the aisle on Capitol Hill have indicated the measure will receive swift action and we look forward to seeing the package signed into law as soon as possible."

Conforming Loan Limts For 2008 - Market Chatter

First today, this from CNBC:

The Treasury and the House of Rep's have agreed to an economic stimulus package that will include a temporary increase in conforming loans to $625,000 in high cost areas.

The bill will now go to the Senate for its approval. Stimulus package is expected to become law by February 15th.

Then a few hours later, this from OFHEO:

For Immediate Release
January 24, 2008


STATEMENT OF OFHEO DIRECTOR
JAMES B. LOCKHART ON CONFORMING LOAN LIMIT INCREASE

We are very disappointed in the proposal to increase the conforming loan limit as we believe it is a mistake to do so in the absence of comprehensive GSE regulatory reform. To restore confidence in the markets we must ensure that the GSEs’ regulator has all the necessary safety and soundness tools.

Yesterday Chairman Dodd talked about moving a GSE reform bill early this year. We are ready to work with him and the Senate Banking Committee. We will also be working with Fannie Mae and Freddie Mac to ensure that any increase in the conforming loan limit moves through their rigorous new product approval process quickly and has appropriate risk management policies and capital in place.

###

OFHEO's mission is to promote housing and a strong national housing finance system by ensuring the safety and soundness of Fannie Mae and Freddie Mac.

------

Controversy! Borrowers and Mortgage Professionals in high cost areas are drooling over this, and OFHEO is cringing. A wet blanket for Bush's stimulus package. We'll see how it all unfolds...

So what do you do about it? If you have a loan balance (combined or in a single lien) somewhere between 417k and 625k, you need to get ready. Refinancing into this market is going to make sense under most circumstances, as we have seen 30 year fixed rates as low as 5.250% for conforming sized balances this week. Call your broker to discuss it. The landscape for borrowing money has changed dramatically over the past 6 months. If your broker has quit the business, and left you to figure it out on your own, get in touch with me here.

John Mauldin Waxing Political

Frequent visitors know I am a fan of Economist John Mauldin (recently voted as the runner up to Warren Buffet for MotleyFool's Investor of the Year Award). I find his economic insights both informative an entertaining, and his newsletter can become addictive to be perfectly honest. Give it a try here.

I don't usually get into politics, mainly because I find it difficult to find politicians worthy saying nice things about. And you know what they say about what to do when you can't think of something nice to say.

But if Mauldin can make an exception to the rule, I can at least point toward his newsletter. I think it is important to read. I can point to several cases where politics over-ruled economics and caused major problems in our economy (take The Great Depression for one). There is a real danger when politicians pander with empty promises that they know they cannot (or should not) back up. Telling the voting public what they want to hear - or what the candidate thinks they need to hear - when it isn't realistic or good for us anyway is a reckless but common practice by these folks. I'll leave it to Mauldin to pick up from here to illustrate why when it comes to our economy, almost all politicians are donkeys.

Read it here. Enjoy...

BART Fares Are Up Jan 1

BART fares are up as of January 1, 2008 - 10 to 30 cents per trip. Minimum fares are now at $1.50, while longer trips, such as Millbrae to Pittsburg are up to $6.60.

Small adjustments like this may not seem like much, but over time they can add up. Understanding the costs of homeownership means consideration of several overlooked factors - such as commuting costs. When fuel and transportation costs on the rise, something called an "affordability index" is altered. This might make the less-expensive homes in the outer-lying metro areas effectively more expensive.

When planning a new home purchase, it is best to be cognizant of all true costs associated with your decision. BART fare inflation might be small one, but there are so many other factors worth evaluating. Make sure you understand how to evaluate variables like this, opportunity cost, etc. You can email me if you have questions.

Spreading Rumors

You may have noticed that Countrywide’s stock price is down 20% this morning, into the $6 range. The price is down based on rumors of a credit downgrade and possible bankruptcy filing.

From a colleague of mine:

"One buddy, who works for a large investment bank, wrote to me and said, “Investors are literally buying thousands upon thousands of puts to bet on its demise - keep in mind every thousand puts is equivalent to 100K shares of stock - I have seen about 100K puts change hands myself - that's 10 million shares.”

Countrywide's fate has big implications for the mortgage market and the mortgage industry. There are a lot of eyes on this...

Paul Kasriel Celebrates Festivus

This one is worth reading. Kasriel (Northern Trust) is a consistently enjoyable read. A little more playful than your typical economist, his recent piece is a Seinfeld-themed, economic strip search of the American Household. And the message is a serious one.

Don't let the dark prognosis ruin your New Year's good times though. While Kasriel makes some great illustrations and highlights some important forces at work, they are not measured against any of the positive forces in our economy. Its always a tug of war out there, and our path forward will follow the balance...

Is The Writing On The Wall? Or Is That Just The Artwork?

In a memorable essay about a year and a half ago, John Mauldin (one of my favorite economic writers - you can read more here) discussed correlations between economic cycles and the markets for Wine, Race Horses, and Fine Art. His commentary suggested that these three items tend to see a spike in value at the tail end of economic boom, as investors feel wealthy and look for alternative places to speculate on investment value. It is an interesting theory. At the time, he noted some recent value increases in these markets, and expected that our economy would be soon slowing (for other reasons - this was just 'another barometer'). Perhaps he was just a bit early.

The markets today are much less confident, and we are seeing a zigzag in the main indexes with frequent 3-digit gains or losses. Volatility is a sign of uncertainty. The near-term future of the economy is a subject of debate right now amidst the mortgage market and credit market meltdown/paralysis/crunch/etc.

This article caught my eye recently. I had not realized this, but I guess the market for Fine Art is still on a tear (I can't comment on Race Horses or Wine). Just an interesting theory to keep aware of as we are all looking for signs of whats coming next. It feels like any day now we may see a market top, and a realization that we are in (or about to be in) a recession. But I also hope we can digest this whole subprime episode in small bites, and move on without too much damage. I won't be making predictions investment decisions based on the value of Fine Art, but I can't shake that concept either.

Mortgage Relief Act HR 3648 Update From CMPS

Update # 1 - Mortgage Relief Passed by Congress & Signed Into Law by the President!

On Thursday, December 20th, President Bush signed into law a bill passed by Congress: HR 3648 –Mortgage Forgiveness Debt Relief Act of 2007. The three major points are:

· Elimination of the “phantom tax” on foreclosures, short sales or other discharges of debt on a primary residence. Consider this scenario: A property is worth $250,000, and the mortgage balance is $300,000. Under the old rules, if a lender forgave the $50k difference as part of a foreclosure, short sale, refinance or loan modification, the borrower had to claim the $50k as income and pay federal income taxes on that amount. The new law eliminates this “phantom tax”, and the forgiven debt is no longer treated as taxable income to the borrower as long as certain requirements are met, such as the discharged mortgage balance must be on the taxpayer’s principal residence.

· The tax deduction for mortgage insurance premiums is now extended until December 31, 2010 instead of expiring at the end of 2007. The same rules apply as before in terms of the income limitations etc.

· The capital gains exclusion is now $500,000 instead of $250,000 for an unmarried individual who sells their primary residence within 2 years of the time their spouse has died. This new guideline applies to sales after December 31, 2007, and provides relief for widows and widowers by giving them a 2 year window from the time their spouse has died to sell their home and receive the $500,000 exclusion. Of course, the same rules apply as before, where the individual(s) need to have lived in the home as their primary residence for 2 out of the last 5 years.

You can read the full version of the bill by visiting the THOMAS Library of Congress web site and searching for HR 3648. Version # 6 (the enrolled / ENR version) is the final version that was passed by both the House and Senate.

Update # 2 - AMT Relief Passed by Congress

After much drama and a few rounds of chicken between the House and Senate, Congress FINALLY passed AMT relief on Wednesday, December 19. The President has indicated a strong willingness to sign this bill into law, and it is currently awaiting his signature. Under this one year patch, approx. 20 million taxpayers have escaped the clutches of the AMT. However, approx. 3.5 million taxpayers are still expected to be subject to the AMT.

If you have questions related to any of these updates, consult with your tax advisor or contact me for more info.

- - - - - - -

*** Posted with help from CMPS Institute

Credit "Issues"

Every day the news headlines seem to set a different tone for this market. Credit "issues" persist, but the Fed is cutting rates, mortgage applications are at a 2 1/2 year high, and then more banks are closing, cutting jobs, or just cutting off access to their money. One day its up, one day its down. Volatility like this is typical of an uncertain market. So until the reach of this market adjustment is defined, we will see choppy waters, and business who lend money will make defensive posturing moves.

Today, the following blurb from "Inside Mortgage Finance":

American Express Stops Allowing Mortgage Payments American Express recently notified some of its customers that it will no longer allow them to make mortgage payments with their credit cards. The company said it will stop allowing such payments in two months. Studies suggest that when borrowers face financial trouble, they default on their credit card payments or auto loans before defaulting on their mortgage. AmEx noted that paying via credit card for fees associated with obtaining a mortgage is still acceptable.

Yikes! I guess it stands to reason that paying a mortgage by credit card would be a great way to rack up frequent flyer miles, but it also seems a slippery slope. I guess I am just amazed to learn this was even possible. But now that it isn't, it represents yet another example of a source of liquidity disappearing...

How's This For "Contained Meltdown"?

I heard one economist recently refer to the current credit markets situation as "well-contained. Sure, contained on Planet Earth..."

A large part of the reason the markets are so erratic lately is because there is so much uncertaintly as to how much damage has been done and not yet acknowledged. How much more money will be lost, and by who? Financial engineering has helped build layers upon layers of cloaking around the bad investment eggs, and the unwind is coming in baby steps (which is good, time helps the markets digest what is clearly a big rotten meal...)

So here's a story from a colleague of mine, which highlights the defensive posturing by creditors who are clearly fearing this "unknown risk" in the market. It also signifies a huge leap in terms of the webbing between "subprime" mortgage issues and areas of other financial concern. This is one way how the virus is NOT being contained...

"How far will this reach into credit cards? One fellow I know received a letter from American Express, dramatically lowering his available credit limit. Our analysis of the credit risk associated with customers who have residential loans from the creditor(s) indicated in your credit report." He has two loans: one from ING Mortgage and a HELOC from JPMorgan Chase. He called Amex and they said: "We were told by Experian that your mortgages are with 'risky lenders". They also said that "information received from a consumer credit reporting agency was factored into the decision." (He has no delinquencies. They listed standard reasons, inquiries, balances, etc.) He wrote, I have never seen credit being denied or reduced for something 100% out of the borrower's control."

Something to keep a watch on as the market feels for a bottom, those in position to lend money for any reason are proceeding with extreme caution...

Conforming Loan Limits For 2008 Set By OFHEO

OFHEO has announced the 2008 conforming loan limits - the limit stays at $417,000. Read the details at the OFHEO website. Were it not for the fear of widespread consumer damage from falling prices and tightening credit, the 2008 limit would likely have been reduced. They have made an exception to the general price-setting methodology to avoid adding insult to injury in the housing market. I discussed that here.

This number is based on national median home value info. For those of us in California, where median prices are higher than other states, hopes of a state-by-state limit are dashed with this latest release. OFHEO’s is not in the position to issue state-by-state guidance unless Congress enacts legislation directing them, which has not happened. And the last news on this was that Governor Schwarzenegger has issued a letter to the leaders in the U.S. Senate and the House of Representatives urging them to support legislation that would raise the loan limit for conforming loans. The median price for a home here is more than $586,000. "This disparity makes these products practically irrelevant in California. This means that for the majority of California homebuyers, the only option is to obtain a larger 'jumbo' loan and pay higher interest rates and fees," said the governor. I'd say that the conforming loans have a shorter reach, but they are hardly irrelevant. In any event, most mortgage professionals say that raising the limit would be the biggest boost for the real estate market possible here in the Golden State.” Unfortunately there is probably not much taxpayer support in the rest of the nation for this…

With rates hitting 2 year lows yesterday, anybody with a rate above 6.500% (on any type of loan) should consider refinancing. Thankfully the conforming limits are staying at 417k, as the Jumbo market is still pricing at a significant premium to conforming products.

A Great Place To Shop For Foreclosures

Its called Catanzaro Way in Antioch, California... take your pick...

There will undoubtedly be some money made by the bottom-feeders of the real estate market. And by bottom feeder, I mean opportunistic investors who use market conditions as a lever to snag inventory on the cheap. They feed off the market at its bottom. Because lets face it, what goes up must come down, but when it comes to housing, or just about any other investment, what comes down goes back up ... eventually.

We'll see a deluge of infomercials hosted by "real estate gurus", featuring average looking folks sitting poolside in a Hawaiian shirt at some resort in Orlando, and talking about their bounties in terms of monthly incomes. For $99 or $599 or 3 easy installments of $129, you can buy the books and tapes that unleash the secrets of how to get your own Aloha shirt and two tickets to the Radisson Disneyworld. We've seen it all before... These guys who make a living selling the recipe instead of baking the cake are arguably the real bottom feeders, but I can't tell you who is/isn't legitimate in that world...

But timing the markets is the challenge. Once you hear its time to get back in, it might be too late. So understanding how to find a good home, a good investment deal, and manage it safely without exposure to excessive risk will be the key until the market booms again. We'll definitely be keeping an eye on this...

Tightening Guideliens In Mortgage Lending

The Economist has a great visual tool this week showing the trend in guideline tightening by mortgage lenders. It looks back almost 20 years, and you can see where guidelines tighten into tougher housing markets - and where they tend to get more loose (below the zero mark) during booming markets. This is quite a spike, with nearly 50% of lenders reporting that they are tightening guidelines right now.

This is why many of the borrowers who have loans entering an adjustable rate period are going to be caught between a rock and a higher payment, as many will be unable to qualify for the same loan they had, let alone a better one.

To some extent, the tightening guidelines are an over-reaction by lenders, who are trying to fix a problem after the damage has been done. Some adjustment is clearly needed, as the liberal guides can be blamed for contributing to the run-up in housing mania. But we are seeing it difficult in some cases to fit some very sensible deals together, as lenders are hyper-sensitive and picking apart every aspect of the file. Some cases, not all.

Like the housing market itself, the lender guidelines will balance out again. Markets have crossed from the manic side of balance to the panic side, and we will stay here until the participants themselves are convinced that a bottom has been reached.

Fragments Of Recent Market Commentary Related To Subprime Contagion

At this point, there has been a deluge of financial press about the implications of a "Mortgage Meltdown", how the Subprime problems started a Credit Crisis, (or Liquidity Crunch, Credibility Crunch, etc), and about speculation into the US Economy's chances to enter a recession. I don't think you can turn over a rock anywhere and find anybody who hasn't 'heard the news'.

In the Mortgage world, this has made everything a little more challenging. Fewer loan programs exist, fewer borrowers qualify, and fewer deals work. Its an over-reaction to the 'easy money' days we saw on the run-up in the housing market. But it will normalize. Just watch...

In the meantime, here are some snippets from articles I've recently read. Each is telling, descriptive, or interesting in the context of this changing economy and shifting housing market (my own interjections are beneath each quote where applicable):

• In an era of spread compressuion and search for yield, the rising tide of amle liquidity covered up a profusion of jagged and dangerous rocks. As the tide now goes out, the rocks now get uncovered. The subprime crisis is a classic example of what can be unmasked at low tide. -Stephen Roach, "A Subprime Outlook For The Global Economy"
  
• As a side note (John here again) This sentiment has already been famously expressed by Warren Buffett as follows: " It's only when the tide goes out that you learn who's been swimming naked", but it was spoken in relation to an entirely different issue - evidence of history repeating itself yet again...
  
• Starting in 1991, the US financial sector began contributing more and more to total US corporate profits as our universities began matriculating relatively more financial engineers (modern day alchemists?) compared to mechanical engineers. -Paul Kasriel, Northern Trust
  
• CDOs, CLOs, SIVs, anybody?
• The central banks have a difficult balance to strike. If policy is too tight, they will be held responsible for creating recessions. If it is too loose, their grip on inflation could slip, as markets and the public cease to believe that prices will remain stable. The great paradox is that the central banks' mastery of inflation has made the task of keeping financial markets safe all the harder. When people are confident that inflation is low and will remain so, they may be more prepared to take on debt.That leads to an expansion of credit and the pursuit of more exotic rewards by lenders. It feeds price rises in assets such as housing and securities. It encourages excessive risk taking. If so, how can you contain inflation without sparking occasional but dangerous bouts of insanity in asset markets? That is a riddle likely to test central bankers for a long time to come. -The Economist, "Only Human"
  
• See Hyman Minsky, and "stability breeds instability"
• The Fed is anxious to calm the credit markets, so that the economy's funds are allocated in line with risk and reward. But even if it succeeds, risky assets are likely to hold much less appeal than they did. The central banker's task is to unscramble price signals distorted by panic, not to protect the markets from a signal that they do not like. -The Economist "Paper Losses"
• Borrowers found that such creditors, in their hunger for higher yields at a time of low interest rates, were quite willing to drop safeguards altogether, leading to a surge of "covenant-lite" loans. Because banks held on to fewer loans, they relaxed their guard. -The Economist, "Switching off the lites"
  
• Sounds like a game of Hot Potato
  
• Providing greater short-term liquidity might ease the taking back of assets on to banks' balance sheets and hence bring down interbank rates. But it would also undermine the efficient pricing of risk by providing insurance, after the event, for risky behavior. -The Economist, "CSI: Credit Crunch"

More Signs Of A Topping Market - From Luxury Alternative Investments, And Some Market Chatter

It has been well publicized that asset markets have cycled higher in value in recent quarters, largely attributable to strong economic growth worldwide, and cheap and easy access to cash, credit and liquidity. Low rates from the US Federal reserve, as well as other countries like Japan (where the Fed Funds equivalent was at 0.000% for 8 years... 0%!! .... 8 years!!!) encouraged investors and consumers to borrow and invest and save, and economies boomed and everything got more expensive. We have seen it in the stock markets, bond markets, housing, commodities, precious metals, corporate buy-outs, you name it.

But there is another set of asset markets that tend to receive a little less publicity, and whose cycles often signal the peaking of exuberant money. In July 06, John Mauldin writes:

"Art, Wine & Horses

One of the recurrent themes of our research has been that it has "never been so expensive to be rich" and that this situation will only likely deteriorate. But even with that in mind, we have to admit that we have been floored by the recent activity at the high end of the market. Take wine, art & horses as examples. As most of our readers will know, modern art, fine wines, & horses, are assets that tend to peak just before the start of a pronounced downturn of the economic cycle. And interestingly, over the past couple of months, these assets have really been shooting up, breaking several records on the way:

* The US$16 million horse. A few months ago, a two-year-old colt who has yet to run a race drew a world record sale price of US$16 million at an auction in Florida, after a furious bidding war between Englishman Michael Tabor and Sheikh Mohammed bin Rashid al Maktoum of Dubai (could he be thinking that horses will run better than Dubai stocks?). The sale broke the previous record of US$13.1 million paid in the mid-1980s for Seattle Dancer. Considering that very few horses ever reach winnings of US$1 million and that the all-time leading earner, Cigar, took home close to US$ 10 million, this is a truly mind-boggling price to pay for a horse that has yet to race a single race (incidentally, Seattle Dancer, the previous record holder, went on to win a paltry US$150,000, racing only five times in his short career).

* The unbottled 2005 Bordeaux. In the world of wine investments, Bordeaux is king, with up to US$3.7 billion worth of wines changing hands every year. Over the past twelve months, much to Charles' chagrin (who likes to say that he is now too old to drink cheap wines), the price of top vintages have surged more than +45%. Much of this latest rally can be attributed to the - yet to be bottled - 2005 vintage. The 2005 vintage from some of the top chateaux are reportedly selling for around US$9,000 per case; as a comparison, in 2003, the same wines went for about US$3,800 per case... While investing in wine can be a very risky business, there is one undeniable advantage: if all else fails, it is a liquid asset...

* The US$135 million portrait. A few weeks ago, Robert Lauder bought a portrait by Gustav Klimt for a staggering US$135 million, the highest sum ever paid for a painting, eclipsing a Picasso sold for US$104 million in 2004. While we (by no means) would pass for art connoisseurs, prices do seem to have reached stratospheric heights. In his latest Gloom Boom Doom report, our good friend Marc Faber, describes his visit to the June Basel Art Fair, where one pure black canvas had a price tag of US$1.5 million... "

Sotheby's International, pedaler of all such things luxury is one good barometer of these markets. Look at a Sotheby's share price 2 year chart. Look like the peak has been reached? The company got kicked by shareholders today after a staggeringly poor auction result. Implication? Money is dried up. Sellers think the peak has been reached.

Paul McCulley of Pimco recently described liquidity as follows:

"... liquidity is not a pool of money but rather a state of mind. ... liquidity is about borrowers and lenders collective appetite for risk, a function of: The willingness of investors to underwrite risk and uncertainty with borrowed money and the willingness of savers to lend money to investors who want to underwrite risk and uncertainty with borrowed money..."

So with all that has been going on along with this subprime virus, and its mutating its way through our credit markets right now, its no wonder everyone is getting a tight grip on their wallets. As new stories about financial loss break daily, the confrontation with reality becomes more real. The reason for the lag between the rising rates (the Fed started raising rates in 2004) and the realization of a liquidity crisis is because, as McCulley puts it, liquidity has more to do with psychology than it does with capital.

Likewise, it will take some time for the recent Fed cuts (and the coming ones as well) to work their way through the markets and translate to brighter attitudes and expectations. Banks - who have tightened up guidelines after-the-fact, will not un-pucker until after a bottom in housing is evident. Great quote from Pimco's Bill Gross, who describes the current situation as "closing the barn door after the subprime mortgage horse has escaped from the barn."

Pretty much. Going to be some bumps in the road, but I would not underestimate the mortgage industry to come up with some creative ways to work through some of the problems, and rescue the good deals from distress; not everybody facing pain in the housing market right now deserves to be there. We shall see...

Considering A Short-Sale?

If you are in a situation where you can no longer make your mortgage payments and your home is now worth less than you owe on it, foreclosure may not be your only option.

A "short sale," in real-estate terms, is a sale of a house in which the sale price is less than what the owner still owes on the mortgage. It is a procedure sometimes agreed to by lenders who often would rather take a small loss than go through the lengthy and costly foreclosure process.

While there are some significant negative consequences to a short sale, an ever-increasing number of properties are being advertised with that label. Proponents say, arguably, that they can be a “win-win-win” situation for seller, buyer and lender. Here's how: the seller gets out of the mortgage liability without facing bankruptcy, the buyer gets the home at a reduced price, and the lender agrees to a loss it considers minimal without going through a foreclosure and being saddled with an unsalable property.

While it may seem surprising that lenders would agree to accept less than what they are owed, they benefit from the process, too, since they don’t have to go through the lengthy foreclosure process and then having to put the property on the market and go through the whole marketing process.

I'm not sure this is a win-win-win, but maybe a win (buyer); lesser-of-two evils (lender); better-than-nothing (seller); business-as-usual (realtor).

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Thoughts go out to those affected by fires in Southern California.....