ECONOMY SOURS BUT RATES HOLD STEADY

November 21, 2008 – 4:53 pm

By Richard Russel — November 21st 2008 — The drumbeat of bad economic news continues, and grows louder. In other economic periods, this would often be accompanied by sliding fixed mortgage rates, but in the risk-averse and panic-market world of 2008, that is simply not the case. Mortgage rates remain stubborn, reflective of the ongoing troubles in housing.

For conforming loans, the decline was slight, a slip of just two basis points from last week. Jumbo thirty-year Fixed Rate Mortgages were the key to pricing the FRMI down this week, as they shed nine basis points to finish at 7.51%.

The only-recently-underway Hope for Homeowners plan for modifying thousands of troubled first mortgages was significantly enhanced this week, and now seems to provide a much greater set of incentives for lenders to press forward with migrating borrowers into more affordable loans. Originally, lenders were required to write-down the value of the first mortgage to a 90% LTV, and any second lien holder would get nothing but a token payment and not even that until the home was sold at some point in the future. The new plan calls for a first lien write-down of just 3.5% (96.5% LTV) and the second-lien holder to gat a cash payment (of, so far, undeclared size) immediately upon the loan’s modification. With a chance to actually recover some money, second-lien holders are certain to become more involved in the process, if not actually pushing first-lien holders to push for mods to happen – and, in light of falling home prices, to happen more quickly. The plan’s change seems likely to get into process into a much higher gear.

That’s good news of sorts. All of these loan mod plans have observes starting to ask questions about “moral hazard” implications, where borrowers who could struggle to make mortgage payments decide they’d be better of failing in order to effect a change to their loan terms. It’s not out of the realm of possibility that some borrowers will see a potential loan mod as some perverse inducement to let their loans start to fail – but any borrowers pondering such a choice should be aware that both the ability and willingness to make payments are big considerations in a loan mod. Skipping payments will also further damage their credit rating, making access to new credit in the future more difficult. Bottom line: making such a choice could bring unintended and unpleasant consequences.

Given the state of the economy, we are likely to see more need for loan mods as borrowers lose their jobs amid the downturn. Last week, some 542,000 new applications for unemployment benefits were filed, a fresh cyclical high, and the number collecting on-going benefits (an indicator of new employment options) climbed past 4 million.

Broadly speaking, the economic numbers out this week were sour, and the outlook for improving economic possibilities was strongly downplayed in the minutes of the latest Federal Reserve Open Market Committee Meeting. While the Fed did cut rates at the meeting, the discussion outlined in the document found several Governors questioning whether the lower short-term rates would have any effect in goosing growth, while others expressed concern about the potential for deflation and its effect on consumer spending habits – a marked turn, given that inflation was a serious concern not all that long ago.

Amid difficult financing conditions for projects amid light and variable demand, Housing Starts hit an all-time annualized low in October, coming in at $791,000 new units initiated. (The series began in 1959.) While September was revised up slightly, it wasn’t by much. Building Permits also slumped hard, landing at a 708,000 annualized pace, down from 805,000 in September. With the activity slumping, it’s little surprise that the sentiment index of numbers of the National Association of Homebuilders came in at a record low (1985) for November. Sales and buyer traffic all declines sharply, but expectations for future sales held firm. The buyer’s strike – which began in mortgage-related assets so long ago, expanded into residential real estate cascaded into equities – is fully raging right now. Cash and cash equivalents are king, even when they might have negative real returns to the investor. Short-term Treasuries remain near zero, reflective of the demand for safety and preservation of principal at virtually any costs.

We need to start to think differently about how to get us out of this mess. How about subsidized, cut-rate financing? How about “price mods” or some other form of actual subsidy for a second-home purchase for the best-of-the-best borrowers? Perhaps insurance contracts to protect against home devaluation for new borrowers? Why not dollar-matching investments for the purchase of GM stock – by individuals? Politicians are pondering the usual, traditional methods of spurring growth. We need to start thinking about real incentives for the majority of Americans who aren’t getting a loan mod, bailout, or direct support. Without new reasons to take risks, these folks will continue to pull away from these markets to preserve what they have the detriment of the rest. It’s going to take a combination of fiscal and monetary policy, strong leadership and the will to reward those who consistently have done the “right thing” over time.