David Olson

FOCUS ISSUE FOR THE WEEK: What will be the impact of the Fed ceasing to purchase MBS (mortgage backed securities) at the end of March? There is a range of forecasts for an increase in the interest rate for the 30 YFR mortgage. The MBA sees it rising from 4.97% currently to 5.7% by the end of June. Actually their current forecast (as of February 22) is the rate will rise to 5.2% by March 30. Since unit labor costs are currently plummeting at a record rate, we don’t think that mortgage interest rates will rise that much by then. We think the mortgage rate will more likely be around 5.25% on June 30. The ten year Treasury is currently 3.68%. The MBA forecasts it to rise to 3.8% on March 30 and 4.0% on June 30. There is no evidence of inflation to send it up immediately despite the magnitude of the federal deficit and the end of support by the Fed. We think the Fed and the Treasury will use all its various powers, including increased purchases by the GSEs, to keep the mortgage rate down.

WORLD TRENDS: The Euro hasn’t moved much since last week and is now $1.363. Greece announced a series of austerity measures to encourage a bailout by the European Union, in particular Germany. At present Germany isn’t interested. Adding to the problem was the downgrade of Deutsche Bank by Moody’s on March 4. A default by Greece could trigger several other defaults in Europe.

The DJIA closed the week at 10,566 up 2.3% from 10,325 last week. This week there were 11 positive trends offset by 11 negative trends.

Positive Trends

• Personal spending rose 0.5% in January after rising 0.3% in December.

• Retail Metrics reported that sales at retail stores open a least a year rose 4.1% in February from a year ago. More than three-quarters of retailers who published results did better than analysts had expected.

• PCE (personal consumption expenditures) core prices were flat in January after rising 0.1% in December.

• Productivity for 4Q09 was revised upward to 6.9% from its initial estimate of 6.2%. This drove down unit labor costs from -4.4% to -5.9%. Labor costs fell -1.7% for 2009, the biggest decline reported over the past 60 years since the government has collected data. This is another sign of lack of inflationary pressure. It is more a sign of deflation. Business is in a position to increase hiring.

• The ISM index (The Institute for Supply Management) slowed down to 56.5 in February after being at 58.4 in January but was still above 50. Any number over 50 indicates growth in this index of manufacturing. It has been over 50 for the past seven months.

• The ISM service index rose to 53 in February, up from 50.5 in January. This is the fastest rate of growth since October 2007 and indicates strong growth for the economy in 1Q10. The service index represents 90% of the U.S. economy.

• Factory orders in January rose 1.7%, up from 1.5% in December.

• Initial claims for unemployment were reduced this past week at 469,000, down from 498,000 the prior week. The four-week moving average is 471,000 which is a bit higher than it was last month. Basically, the four-week moving average has been flat so far this year. Continuing claims also fell to 4,500,000, down from 4,634,000 the prior week.

• On March 1, the Federal Housing Finance Agency (FHFA) announced that the Home Affordable Refinance Program (HARP), which was set to expire this June, will now be extended for one year, until June 30, 2011. This program expands access to refinancing for qualified individuals and families whose homes have lost value. So far 188,000 borrowers who owed between 80% and 105% of the value of their homes had refinanced through December. Last September, it was expanded to include borrowers who owed up to 125% of their home value. Up until now, 70% of the mortgages, tied to a similar program called HomeSave Advance, redefaulted. Will that occur with the newly extended HARP? According to estimates by J.P.Morgan 15.7 million mortgages are underwater. If homes prices stay flat, they estimate roughly 13 million borrowers will walk away. If housing prices appreciate 3%, the number of loans underwater falls to 6 million. In either case, there is a big likelihood of our government owning lots of defaulted loans.

• The SNL reported there are 98,913 bank branches in the U.S. as of March 1. This is down 300 or 0.3% from June 2009. The overall count is still 15% higher than in 2002. This is the first decline since at least then. In 2009 the 8,012 banks and savings institutions in the U.S. earned a combined profit of $12.5 billion, down from $100 billion in 2007, according to the FDIC. A total of 140 banks failed, while 179 disappeared through merger and acquisitions. Now 702 are considered by the FDIC to be problem institutions. In addition, the Census Bureau reported 7,806 operating credit unions in 2008. Some of these are also defaulting or disappearing through mergers and acquisitions and their total is also in decline.

• The current rate for the 30 YFR mortgage fell to 4.97% this week, down from 5.05% last week. The decline in the mortgage rate is blamed on low demand due to cold weather and continued high unemployment.

Negative Trends

• The rate of unemployment remained unchanged in February at 9.7% the same as in January. Nonfarm payrolls fell by 36,000 in February, up from the 26,000 decline in January but less than expected. The average workweek declined a bit from 33.9 hours in January to 33.8 hours in February. Hourly earnings only rose 0.1% in January, indicating little danger of inflation.

• The ADP (Automatic Data Processing) reported that 20,000 U.S. workers were laid off in February. This is less than the 60,000 lost in January. The large discrepancy between these two sets of data for the decline in payroll workers is curious but they both show declines in the past two months.

• Construction spending fell -0.6% in January after declining -1.2% in December.

• The Federal Reserve’s beige book for February reported weakness in commercial real estate, weak loan demand, and a soft market for labor.

• Pending home sales fell -7.6% in January reported the NAR. This is down from 0.8% in December. It is a sign of weakness in the housing market.

• In a recent survey, the National Federation of Independent Business found 51% of small employers said slow or declining sales was their biggest problem. This is up 6 percentage points from a similar survey a year ago.

• In 4Q09 Fannie Mae posted a loss was $15.2 billion. In 2009 their loss was $72 billion. In 2008 it had a loss of $58.7 billion.

• The Wall Street Journal reported that the Senate is close to passing a bill to create a new consumer-protection unit within the Federal Reserve Bank (HR4173) If passed, the new law would permit the Fed to take over failing financial companies that aren’t banks and don’t have insured deposits. Regulators would have to option to force any financial company into an FDIC-controlled dissolution if they believed market chaos required such an extreme step. It would also add more layers of supervision on the mortgage industry. Dodd wants this agency supervised by the FDIC whereas Barney Frank prefers the Treasury.

• The 10 year Treasury rose from 3.58% last week to 3.68% this week. This is still lower than the MBA forecast of 3.80% at the end of March.

• Oppenheimer estimates the GSEs will force banks to buy back $21 billion in defaulted mortgages in 2010. This would cause losses of $7 billion, up from losses from buybacks of $5 billion in 2009.

• Mortgage lenders reported to us they are still experiencing lots of fraud and there is a big trend towards the GSEs requiring increased documentation, especially of appraisals.

Biggest strengths: labor productivity and affordability of homes are way up, new home inventories and interest rates are down, rising dollar vs. euro, home prices have been rising for the past seven months, the ISM index has risen for the past seven months, factory orders are up, and durable goods orders are up.

Biggest weaknesses: high unemployment, low consumer confidence, high delinquency and foreclosures, very tight underwriting, no liquidity for jumbo mortgages, increasing bank failures, rising losses on commercial real estate loans, further exodus of mortgage firms, declining new and existing home sales, rising federal deficit, end of Fed support for the MBS market, higher buy back requests by banks from the GSEs, more documentation is being required by the GSEs, and further regulation is coming with the Consumer Financial Protection Agency.

Forecast: slow, rocky growth forcing more government support for housing and the economy.

Future meetings run by Access Mortgage Research:
17th Benchmark Study Meeting for the Wholesale Channel – in Washington, DC, April 12-13, 2010.
17th Benchmark Study Meeting for the Retail and Consumer Direct Channel – May 2010 in NYC.
Access Mortgage Research was founded in 1991 to provide research to the mortgage industry. For more details see www.accessmtgresearch.com or phone 410-772-1161.