One patient came in and said, "Doctor, I have a serious memory problem." The doctor asked, "When did it start?" The man replied, "When did what start?"

That line is short and to the point. Generally speaking, markets like news when it is short and to the point - borrowers are different than traders, who are different than investors, who are different than analysts, who are different than economists. So when the Fed Chairman uses the double adjective "unusually uncertain" to describe the economic outlook, one's opinion, and how one reacts to that quote from last week's testimony, will be different. There is no question that rates are great, and much better than many had forecast for this time of year. But if the Federal Reserve doesn't know what the US economy is going to do in the near (or far) future, what are small business owners, builders, etc., supposed to do?

One important factor which is influencing mortgage rates is that FNMA/FHLMC debt is attractive at present and is finding many buyers. This debt has higher yields than Treasuries and is de-facto backed by the Treasury department. With mortgages there will always be questions on duration mismatch and early pay-offs, but if both Freddie & Fannie pools and Treasury debt are guaranteed by the US government, why not obtain the higher yielding paper? On average the mortgages which comprise the debt are of substantially higher quality than those of, say, 2-7 years ago. These are fully documented, low debt ratio, high credit score, true A-paper loans. For the most part, we are past the worst in terms of real estate value erosion so there will be fewer "walk-aways" by folks who owe more than the property is worth.

 

Not only are rates helping originators, but mortgage bankers' profit margins are currently very high. When rates dropped in April, instead of following the MBS prices tick-for-tick, many firms built in higher spreads both to build up their reserves and to limit volumes (have to watch that overhead!).  All of this is easier to do now than in the past, given the lower competition. And as I have mentioned in the past, would you rather do 1 loan and earn a 2 point profit or 2 loans and earn a 1 point profit? Doing more loans for less margin, other things being equal, strains a firm's capital, warehouse lines, operations staff, exposure to buybacks, etc.

Although no move is expected until 2011, a story in the Wall Street Journal on Freddie's and Fannie's future stated that Treasury Secretary Geithner said the government should retain "some type" of federal guarantee to ensure that Americans can easily finance home loans. Fannie and Freddie were taken over by the government in 2008, turning their implied government guarantee into an explicit guarantee and receiving almost $150 billion in aid. On "Meet the Press", Mr. Geithner promised the administration would "bring fundamental change" and said it wouldn't "preserve Fannie and Freddie in anything like their current form" but that "there's going to be a good case for taking a look at preserving or putting in place a carefully designed guarantee so, again, homeowners have the ability to borrow to finance a home even in a very difficult recession." Since F&F own or guarantee more than half of the nation's $10.2 trillion in mortgages it is not a "slam dunk" issue, and the Treasury received many responses during the 90 day public comment period (which ended last week).

An editorial was quick to point out that, in a twist of fate showing where things stand, Freddie and Fannie have become more central than ever to our mortgage business. The two companies have been nationalized. They underwrite the vast majority of all new home loans, and they own or guarantee about half of all the mortgages outstanding. Per the WSJ editorial, "There's simply no room in this story for two giant government-sponsored enterprises that distorted the housing and credit markets, took advantage of implicit government guarantees to operate at leverage ratios that would have made Lehman Brothers executives blush, and finally, and predictably, collapsed under the weight of that leverage and their bad bets on the housing market."

 

An error was made yesterday in the description of Freddie Mac's HARP product. It is not true that only the current servicer can originate a Freddie Mac HARP ("Relief Refinance Mortgages") Any Freddie Mac Seller can originate and deliver Relief Refinance Mortgages to Freddie using "Open Access". Some investors, such as Wells Fargo, have overlays which restrict this product, whereas others such as Flagstar, Fifth Third, etc offer the "Open Access" programs where they will take any lenders' Freddie Mac deals. ReliefRefinance

More comments from the originator trenches. A processor wrote to me and said, "Scientists believe that to make a pound of honey, it takes 50,000 miles of bee flight. Now it seems that it takes that many steps in doing a mortgage, with the difference being that bees have had millions of years to adapt."

A loan officer wrote and said, "New legislation created to control compensation during the 'Golden Years' when the markets were not normal are forcing originators out of the business since the 'Golden Years' no longer exist.  Current markets are still not normal and could be called the 'Suffering Years' as the business cycle continues to struggle to return to normal.

Originators, real estate agents, appraisers, title attorneys, etc., have always had to endure good and bad business cycles, but the government adding all these 'fixes' for a market that no longer exists to one of the worst markets ever makes getting through it even more difficult while it reduces competition and increases costs to the consumer. Who wants a minimum wage employee to help you with the biggest purchase of your life?"

A loan agent wrote, "Underwriters have come up some of the most insane conditions.  Some are so ridiculous, you have to laugh. I recently had a 58-yr old borrower, with credit scores above 800, who was purchasing a second home. The LTV was roughly 60% and the DTI ratio was 30%. The borrower, through our underwriter, was asked by a major lender to provide a letter of explanation of why he had 8 mortgages in his life time. And he provided it."

There has been some press lately about a "national mortgage" since the government seems to be gathering things under their umbrella. A Barclays analyst wrote, "A national 4% mortgage rate to all borrowers makes no sense at this stage. This strategy would require the government to subsidize this program and increase their already enormous balance sheet. What is far more likely is GSEs indemnifying the originators from early pay default risk for their existing g-fee loans. For each loan that gets put back to the originator, they lose 50 cents on a dollar. We believe this a large reason why originators have been focused on refinancing the most pristine borrowers (High FICO, Low LTV, and low DTI). In addition, anecdotally it appears that borrowers with very high DTI can't even get a mortgage. Bottom line, there is no reason why the GSEs can't provide amnesty for existing borrowers and at the same time insulate the originator from early default put back option. If the liability to the originator is removed, there is no reason why they can't refinance the $1.8 trillion of '04-'08 mortgages."

 

That being said, at this point many of these borrowers either no longer qualify under current guidelines, or their properties are underwater. Barclays estimates that even with rates in the mid-4% range (250 basis points below their mortgage rate) only 1 out of 10 borrowers in the 06/07 6.5s can refinance over the next year. "Absent of a policy change, this number is not going to change considerably even if mortgage rates continue to grind lower. Clearly these borrowers have combination of high LTV, high to infinite DTI , low FICO and low documentation. Why can't the government implement a strategy that all existing borrowers who have been current on their mortgages for the past 2-3 years be exempt of these requirement subject to ~ 50 bp higher g-fee? By waiving the LTV/DTI/FICO/Doc requirements in lieu of 2-3 years of being current on their payments, as a means to a streamline refinance program, the government will increase the agencies g-fees, lower the borrower's monthly payments, and provide incentive for remaining homeowners to stay current on their mortgage so that they can take advantage of a streamline refinance program in the future.

Some originators moved into offering mortgage relief services. Most are honest business people, but woe to those who aren't - and unfortunately these are the ones that garner the most publicity. Federal regulators (the FTC) have banned eight individuals and companies from selling mortgage-relief services, settling charges that they used false advertising to deceive homeowners facing foreclosure by paying $29 million in fees that they collected from clients. Some of the companies used names that deceived borrowers into believing the firms were participating in the Obama administration's $75 billion mortgage modification effort, known as "Making Home Affordable." Steven Oscherowitz (Federal Loan Modification Law Center), Loss Mitigation Services Inc., Direct Lender, Dean Shafer, Marion Anthony "Tony" Perry, Bernadette Perry, Salvatore and Nicholas Puglia (Hope Now Modifications and Hope Now Financial Services Corp.) were all either banned from the industry and/or required to pay large penalties.

 

Monday, once again, due to supply and demand issues, mortgage prices did well relative to Treasury prices. (Things started off quietly, but then traders reported that an "Asian buyer" of size emerged helping prices, and the $1.8 billion in origination sales were easily absorbed.) Even with the yield on the 10-yr Treasury moving above 3%, mortgage prices actually closed the day better by .125. A big surprise came from the report showing that U.S. single family home sales surged (up over 23%) in June coming off a record-low in May. At this sales pace, inventory is at 42 year low. The percentage increase last month was the largest since May 1980, and it partially unwound May's 37% drop. The median sale price for a new home fell 1.4 percent last month to $213,400, and over the last year prices are roughly unchanged. The New Home Sales number pushed rates higher.

 

As mentioned, Monday the 10-yr closed at about 3%, with 30-yr mortgage prices better by about .125. Roughly $1.8 billion was sold, and, as usual, mostly 4 & 4.5% securities. Even though 3.5% securities are trading, and priced just below par, the liquidity is just not there yet for much volume to show up. Today we have more housing news with release of the S&P/Case-Shiller Housing Price Indices for May showing unexpected improvement in several cities and a decent overall 10-city and 20-city improvement. We will also have the 10AM Consumer Confidence number for July, expected lower, and the first leg of this week's Treasury auction ($38 billion of 2-yr notes). Ahead of that the 10-yr is up to 3.04% and mortgage security prices are worse by .125-.250.