Posts Tagged ‘mortgage’

The Essence of our Predicament

Tuesday, January 29th, 2008

The essence of our economic predicament is that the cost of debt has risen dramatically on instruments the Fed can’t control: longer durations and riskier issuers.

This happened to corporations and consumers simultaneously. Both rises were essentially unexpected, i.e. not priced in. Now we’re getting whipsawed as realization of the new cost of capital is priced in.

Other things equal, disinflation or deflation is the logical result of an uncontrolled, unexpected, sustained, large increase in the cost of capital.

Fed rate cuts can mitigate that, but not as much as desired, because most of the problem is concentrated at the other end of the risk and duration spectrum, e.g. 30 year mortgages or BBB corporate debt.

This essentially all resulted from a loss of faith in the judgment of the rating agencies, and in the solvency of the debt insurers. The Fed rate could go to zero, and banks would still be afraid to lend to a BBB credit, because they can’t be sure it’s really BBB any more, or that they can insure reliably against a default. So restoring faith in the ratings agencies and debt insurers is probably a prerequisite
to flattening both the yield curve and the risk premium.

As long as it stays like that, we appear to be facing an era in which asset prices are falling and cost of servicing debt is rising, so that seems deflationary. The alternative, which I prefer, is to cut Fed
rates so aggressively that things go the other way, i.e. dollar falls, durables prices rise, etc. But keep in mind that fewer people have much equity left to buy things with, no matter where rates go.

That’s how it looks from this armchair.

Prediction realized

Thursday, January 24th, 2008

Wall Street Journal, January 24, 2007:

“The package is also likely to temporarily raise the conforming loan limits for Fannie Mae and Freddie Mac, beyond the current $417,000, which would allow the government-sponsored companies to buy bigger loans in areas with high housing costs. Rep. Barney Frank, the Massachusetts Democrat who chairs the House Financial Services Committee, said the new limit would be 125% of a metropolitan area’s median housing price, up to a cap of about $700,000.”

Exactly as predicted here five days ago. However, I failed to predict that the desire to subsidize political donors would be bipartisan.

I predict…

Saturday, January 19th, 2008

The GSE conforming mortgage limit, which went unchanged for 2008 — and which regulators currently insist is immutable and untouchable — will be raised or eliminated within 90 days.

How could an about-face occur so quickly? Because it is the style of this presidential administration to recognize emergencies late, initially deny their existence, then respond abruptly in a way that (i) benefits wealthy patrons and (ii) has no regard for future consequences.

The White House mortgage bailout plan of December 2007, for example, mainly bails out mortgage servicers, not mortgagees. By incentivizing hapless homeowners to continue paying teaser rates on homes with negative equity, defaults are spread over a longer period, allowing servicers to manage them more profitably. The loser is the mortgagee, who is led to believe he will somehow recover an investment that is already lost, when in fact his most logical action is to default or do a workout with the servicer.

With that in mind, the basis for today’s prediction is that subprime fallout has reached the prosperous (note: the Reuters article referenced here confuses “wealth” with “prosperity,” a common error in America). There was a brief window during 2005-2006 in which a family with an income of, say, $250,000 could “afford” a $2m home with no money down. Their situation is now every bit as untenable as that of a blue-collar family in Cleveland: they cannot qualify for a fixed-rate refi, because their income is too low; they cannot sell, because they have no equity; but they cannot stay where they are, because the payment reset will kill them.

Suddenly, election fundraisers are no doubt hearing, “I can’t donate to your campaign because I can’t afford my mortgage.” This is a problem the currently broken GOP can understand. We should expect White House-controlled regulators to drop everything and look for a quick fix. Allowing Fannie to hold mortgages on homes in Greenwich, Palm Beach and Newport Beach, which would drive fixed rates down on large mortgages, is such a fix.

Should it be done? Probably not. Will it? Yes. There are few other options. You heard it here first.

Life Imitates Monopoly

Tuesday, December 4th, 2007

Ah, youth. How fondly I remember the endless Monopoly games of summer, in which the winner would loan ever greater sums to the loser, thereby averting bankruptcy and continuing the game.

“You landed on Park Place again? What a shame! And me with hotels there. Don’t worry, I’ll loan you the $1,500, and you just keep right on rolling.”

Evidently the scions of our federal government were similarly raised. Lenders going insolvent? No problem, we’ll loan you more, and cheaper, to keep you going. Borrowers feeling strapped? No problem, we’ll simply tear up your mortgage contract and write a new one where you pay less.

Japan tried this in the 1990s, in case you don’t remember.

Argentina, not Japan

Tuesday, December 4th, 2007

Pundits worry the mortgage collapse may push us into Japan-style deflation. That’s one possibility, but there is a more likely one.

Japan headed into its long deflationary spiral with a mostly balanced federal budget, high trade surplus, immense foreign reserves, immense personal savings, low unemployment, and high educational level. This buys an awful lot of flexibility.

The US teeters on a similar precipice, but with no net underneath: gigantic federal budget deficit, large trade deficit, high personal debt, high corporate debt, net debtor status, and uneven educational level.

The stage is thus set more for Argentina than Japan: banking crisis, hyperinflation, currency collapse. I’m not saying it will happen; only that it’s more likely than the Japan scenario.