Two-Month Forecast: January 9, 2009
Preface
It was quite a year.
Since our last forecast, significant portions of the residential mortgage market have been reshaped due to government intervention and — in some ways — due to a lack of government action. We’ve come through an election cycle, seen hundreds of billions of dollars spent trying to comfort financial markets, and heard the promise of hundreds of billions more dollars in various forms of ’stimulus’ that may be on the way. For mortgages and real estate, at least one important support is in place; others may arrive under a new administration.
On November 25, the Federal Reserve announced a plan to support the good-credit-quality residential mortgage market like never before: the government offered to purchase up to $100 billion in Fannie Mae- and Freddie Mac-issued debt while purchasing up to a half-trillion dollars of agency MBS in the open marketplace. With a new, deep-pocketed player in the market — especially one unlikely to turn tail and run at the first sign of trouble — the mortgage market collectively found a plan it could rally behind and fully support. Conforming mortgage rates (notably 30-year FRMs) enjoyed a substantial drop in rates. At this writing, we’re witnessing a real refinancing opportunity; home purchasers seem to be starting to take notice as well.
While this was going on, an ongoing rush to safety and security was fully in place, driving Treasury yields to historic lows. Those influential benchmark interest rates served to push mortgage rates somewhat lower on balance.
Recap
When we wrote our last forecast, we expected interest rates to trend downward. HSH’s Fixed-Rate Mortgage Indicator (FRMI) — an average inclusive of conforming, jumbo and “expanded conforming” loans — was expected to trend in a range of 6.90% to as low as 6.40% over the forecast period. However, neither we nor anyone else could have foreseen the Fed’s foray into the market, and the downward pressure for rates which ensued. The range for the FRMI over the nine-week period was 7.05% to 5.85%, an unusually wide swing. This was much the same for the FRMI’s 5/1 Hybrid ARM counterpart; we expected a 6.70% – 6.25% range, but instead got a 6.80% to 5.80% one. Unlike the FRMI, much of the drop in rates here came in the last four weeks along with what seems to be some loosening in the credit markets for products other than 30-year FRMs.
Much of the FRMI’s downdraft was due to the drop in conforming 30-year FRMs, which stood at 6.06% the day before the Fed’s announcement. The daily national conforming average declined to a low of 5.06% in late December before bouncing off the bottom somewhat. Jumbo 30-year FRMs didn’t fare quite as well, as those markets remain more viscous than the better-flowing agency market. Still, the improvement here was substantial; rates had moved down somewhat before the Fed’s announcement but remained at a mid-7% level, but the last five weeks have seen some improvement in liquidity, easing to about a 7% level at this writing.
Forecast Discussion
The influence of the Fed’s announcement cannot be overstated. The drop in conforming rates opens up a number of possibilities to help move several markets forward. It goes without saying (though many would-be borrowers are finding out the hard way) that the program is aimed only at solvent homeowners with equity and good credit (among other requirements), but a lender with a portfolio of first mortgages will see at least some of those now-illiquid holdings retired, and the resulting cash will allow for a more natural rebalancing of books over time. That’s obviously preferable to resorting to a fire-sale-at-a-loss situation to raise desperately needed capital.
This process not only helps a lender to become more solvent, but can also allow for those returned funds to be used in other ways — perhaps to purchase jumbo mortgages, for example. We suspect that this is part of the reason for the drop in jumbo rates noted above, accompanied by the search for better-yielding investments, given that highly-safe Treasuries now yield virtually nothing.
Of course, the process of rebalancing portfolios will take some time, but that might prove to be a good thing, since that time can also be used to help unwind many of the impossibly complex debt instruments which have tied the markets into near-Gordian knots. As well, the fee income generated from refis produces profits and should help to support mortgage-related jobs. Of course, the layoffs in banking and mortgages over the past two years meant that the industry is quite unprepared for the onslaught of mortgage applications, and unlikely to want to re-hire experienced hands on a permanent basis, so we’ll need to see what develops in this regard.
The chance to refinance — which helps a household to recast its own balance sheet — also promotes solvency, and may also potentially pump billions into the economy over the next year as lower debt burdens take hold. This is powerful stimulus of its own accord which costs present and future taxpayers nothing, even if investor returns may be lowered somewhat overall.
The Fed also took several occasions during the forecast period to lower short-term interest rates to historically low levels. With present-day interest rates near zero, the effects of traditional monetary policy using the Federal Funds and Discount Rates have fully run their course. The Fed’s next moves must all come in the form of “quantitative easing,” which is Fed-speak for various forms of direct market manipulation (such as the mortgage-support plan described above).
One influencing factor in the markets — the Troubled Assets Relief Program, or TARP — underwent a significant change during the forecast period. Originally slated as a fund to remove bad assets from lender and investor books, the Treasury ultimately abandoned that mission as far too complex and time-consuming. Instead, the Treasury opted for direct injections of capital into troubled institutions through the purchase of preferred (non-voting) equity positions. While this means that these firms still have bad loans on their books, they may now have adequate capital — and time — to manage those troubles more effectively.
Aside from those items, the economy continued to stagger along, and late October and early November’s financial markets came to a virtual standstill. So deep were the troubles in obtaining capital that auto makers had to go to Washington hat in hand on two separate occasions to ask for assistance, some of which was provided by the outgoing administration.
After months of erratic performance, the economy was declared to be in a recession by the National Bureau of Economic Research. When the announcement came in December 2008, it was unsurprising that the NBER dated the beginning of the downturn to December 2007, since job losses have occurred in each month of 2008 (with perhaps the worst reading to close the year forthcoming in December’s data).
In the midst of all this, a historic election took place, and a new administration is slated to hit the ground running in just a short while with as much as a trillion dollars in new spending to hopefully revive the economy. That spending may ultimately serve to bolster economic growth, but history teaches us that the effects of any such spending will come much later in the year at the earliest. More pronounced stimulus may come from the collapse of gasoline and heating oil prices and the loosing of cash through refinancing noted above.
It’s expected that one of the new administration’s priorities will be to slow the rate of foreclosures through a variety of measures. While this problem certainly does need to be addressed (provided a borrower has both the incentive and capability to remain in the home), we’re of the mind that more important to the market would be support for those good-credit-quality homeowners who are now underwater in their loans.
Without equity, these borrowers cannot refinance and cannot sell without either losing money or costing the lender (investor) money though a short sale or foreclosure. Many millions of homeowners are in this situation, and as home prices keep sliding this problem worsens with each passing day. Brighter minds than ours will need to come up with a plan — grants, insurance contracts, subsidies, whatever — but with some $350 billion left in the TARP fund, at least some portion should be dedicated to this issue. Presently, the only market incentives for these homeowners are perverse ones; that is, they typically can’t get help unless they begin to fail. In finance as in medicine, prevention is the best cure.
(There’s also been little, if any, discussion of the effects of high property taxes on the nascent homebuyer movement. We’ll have more to say about this, in time, on our blog.)
There is little doubt that the economy will remain highly challenged over the next nine weeks, but we think there is reason for at least cautious optimism.
Even though the job market is weakening, home affordability is rising due to the fall in interest rates combined with sliding home prices. Sooner or later this will begin to stabilize home sales; we are coming to believe that there will be a mild recovery as the spring approaches — provided no unforeseen economic event occurs.
Lower energy prices will add tens (if not hundreds) of billions of dollars back into the economy, should they hold at these levels. While that cash seems to be ending up in savings at the moment, Americans usually find a way to spend at least some of their holdings, so at least some economic boost should result. Added to what’s shaping up to be a massive stimulus package from the new administration — expected at this writing to be a combination of fairly modest tax cuts and infrastructure outlays, among other ideas — the economy’s decline should stop, even if real improvement may lie in the future. Just the announcement of a actual plan can have wide-ranging supportive effects.
The incredible wash of cash into the financial system with nowhere to go suggests that we should see at least some risk appetite forming. Ultra-safe Treasuries and bank obligations will probably continue to get the lion’s share of those dollars, but mortgages do seem likely to get at least some increased interest.
Forecast
It’s widely agreed that without the government’s influence, the mortgage market would be an even messier place than it already has become. That durable support is crucial to stabilizing the market, at least until private capital again develops an appetite for investments with greater-than-zero risks. With a new administration coming in, any number of plans may come to manipulate interest rates still lower, but that could delay any resumption of private interest, since that paper would feature very low yields. In this way, we find ourselves in a tenuous situation, with one overarching question: Does the good-credit-quality mortgage market need more incentives than the near-50-year-low interest rates already in the market… and if so, who deserves that additional support? (If you’ve read this far, you already know our answer.)
The Fed’s massive November plan moved conforming mortgage rates down to present levels, and it does seem unlikely that any new plan would be of comparable size and magnitude. That suggests that, absent any significant new government influence, there is limited downside for conforming interest rates over the forecast period. However, the refinancing/portfolio rebalancing detailed above could exert some continued downward influence on jumbo mortgage prices.
This being the case, we expect that HSH’s FRMI should decline somewhat over the next nine-week period, likely wandering in a range from about 6% to perhaps 5.5% over that time. The overall average for 5/1 Hybrid ARMs will probably be stickier, though, as there’s little demand for these ARMs in the market (especially since many are prices above their fixed-rate counterparts, particularly in the conforming market) so we think the rang for them might be 5.95% to perhaps 5.60% over the next couple of months.
If nothing else, it should be an interesting end of the winter. Check back in early-mid March and we’ll see how this plays out.
Popularity: 5% [?]
