HSH Market Trends

Economy Sours But Rates Hold Steady; Loan Mods Modified, Again

November 21, 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’s simply not the case. Mortgage rates remain stubborn, reflective of the ongoing troubles in housing.

We saw a slight dip in rates this week. HSH’s Fixed-Rate Mortgage Indicator (FRMI) eased by seven basis points (.07%), finishing the week at an average 6.67%. Five-one Hybrid ARMs managed a larger downturn, losing 20bp to land at 6.32%.

HSH’s FRMI includes conforming, jumbo and expanded conforming mortgage prices. See the latest trending charts for these and other series.

For conforming loans, the decline was slight, a slip of just two basis points from last week. Jumbo thirty-year FRMs 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 writedown of just 3.5% (96.5% LTV) and the second-lien holder to get 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 the process into a much higher gear.

That’s good news of sorts. All of these loan mod plans have observers starting to ask questions about “moral hazard” implications, where borrowers who could struggle to make mortgage payments decide they’d be better off 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 borrower pondering such a choice should be aware that both the ability and the 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. President Bush signed a bill today to extend unemployment benefits by seven weeks to help displaced workers in states where the unemployment rate has topped 6%.

Broadly speaking, the economic numbers out this week were pretty sour, and the outlook for improving economic possibilities was strongly downplayed in the minutes of the latest Federal Reserve Open Market Committee Meeting. The minutes (from October’s meeting) painted a gloomy picture and was among the most downbeat outlooks we’ve seen yet. While the Fed did cut rates at the meeting, the discussion outlined in the document found several Governors questioning whether 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. (Deflation occurs when prices decline across the economy. That can be bad, since it can lead to falling profits which results in shrinking incomes and fewer jobs, as well as increased defaults on loans.) The FOMC’s own forecast gave strength to the argument that the recession in growth might last until at least mid-2009 — and could persist for a while longer than that.

Prices are starting to decline, and quickly at that. Led by falling energy and commodities prices, the Producer Price Index fell by a whopping 2.8% in October, a much larger drop than expected. “Core” PPI (no food or energy inputs) wasn’t quite as tame, ringing in at a second-consecutive 0.4% lift. Over the past year, headline PPI has risen by 5.1%, while core PPI is up by 4.4%. The headline annualized rate for PPI has fallen by nearly half in just three month’s time. Upstream prices pressures for PPI in intermediate and crude goods suggest that more price declines are in the offing, as well.

The Consumer Price Index also declined more than expected, losing a full 1% during the month. The now-3.7% change in costs over the last year is much milder than the 5.5% seen in July, and even the “core” PPI managed a 0.1% decline. Headline prices have now declined by 4.4% (annualized) over the past three months, and core consumer prices are up just 2.2% over the past year. At the rate we are proceeding, we will be back to price “stability” quite quickly.

If there’s one bright spot, it’s that gasoline prices continue their march downward, adding crucial dollars to stressed household budgets. After worsening the early stages of the economic downturn by absorbing billions of dollars out the economy at $4 per gallon, prices have now descended to below $2 per gallon.

Amid difficult financing conditions for projects amid light and variable demand, Housing Starts hit an all-time annualized low in October, coming it at 791,000 new units initiated. (The series began in 1959.) While September was revised upward slightly, it wasn’t by much. Building Permits also slumped hard, landing at a 708,000 annualized pace, down from 805K in September. With that activity slumping, it’s little surprise that the sentiment index of members of the National Association of Homebuilders came in at a record low (1985) reading of 9 for November. Sales and buyer traffic all declines sharply, but expectations for future sales held firm.

After hurricane and strike influenced numbers pulled it down, Industrial Production (IP) flared higher in October, rising by 1.3%. Output rose across the board for mining, manufacturing and utilities, but much of that was due to resumption interrupted activity rather than a fresh spurt. As well, the percentage of factory floors in active use nudged higher, rising to 76.4% from September’s 75.5% level. Despite the improvement this month, conditions which might foster future improvements in IP don’t seem to be forming, what with all the issues in the economy.

Those were evident in the second month of truly awful numbers about manufacturing activity in the New York and Philadelphia Federal Reserve Districts. In New York state, the measure of activity contracted to -25.4 in November, and that after a -24.6 reading in October. Philly’s reading was worse, with a November measure of -39.3 on the heels of a -37.5 mark the month prior. Trouble getting financing at favorable terms no doubt is contributing to the downturn, but downstream demand is vanishing fast, too, as consumers retrench.

That retrenchment is reflected in the ABC News/Washington Post poll of Consumer Comfort. A new all-time low of -52 (the series began in 1986) was reached during the week of November 16, as crashing stock markets and battered retirement investments have deepened worries about the future, let alone exacerbated concerns about the more immediate troubles faced today.

The buyer’s strike — which began in mortgage-related assets so long ago, expanded into residential real estate, and 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.

While much of the discussion and effort put forth so far has been to try to help people, companies and systems which, either by accident or design, took on far too much risk to handle, little to date has been done to try to move the more prudent — daresay, more conservative — off their respective fences and into more risk-taking behaviors. At this stage of the game, only those who haven’t previously acted imprudently can effect real change to the economic state in which we find ourselves.

The imprudent have had their day. Those who answered the siren song promising a reward for employing too much leverage are seeing their needs addressed to the extent possible. Those who resisted, however, have received nothing. Where is the inducement for a good-credit borrower who has always acted responsibly to step up and buy a(nother) home to support home prices? Presently, all the benefit accrues from waiting for a lower price, further damaging the market. The same is true for investing in equities, or even buying a car made by a Detroit company. People of fair means — those with incomes, equity in their homes, savings — are continually being asked to support those without, and the burden increases daily.

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 — public work projects and such — and those are fine, too, if way too slow as to cause any immediate effect. We need to start thinking about real incentives for the majority of Americas 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 — to 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.

Enough rant. Thanksgiving is upon us, and despite our troubles we have much to be thankful for, even as we hope for more and better. Mortgage rates should probably ease next week, and likely more in the weeks ahead as mortgage credit demand wanes into the holiday season. If recent trends are any indication, the retailer’s “Black Friday” may be “Bleak Friday” when all is said and done.

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