'Falling oil trumps a sinking globe'

Commentary: Financial companies’ downsizing stresses system
By Lou Barnes, Friday, July 18, 2008

A Fannie/Freddie Treasury guarantee on the way means mortgage rates have fallen, right? The huge spread between 10-year T-notes and mortgages has closed, for sure? All these mortgage-backed securities as good as Treasurys, they’re trading the same way? Fannie and Freddie can borrow cheaply, so mortgage rates will be cheap, too?

All wrong. This week’s mortgage trading removes any remaining dispute about the difficulty facing the financial system, the economy and housing. Mortgage rates have soared to 6.75 percent, up 0.375 percent in a week, the spread over 4.07 percent 10-year notes wider.

All long-term rates had a rough week. The CPI jump got the initial blame (1.1 percent in June alone, 5 percent year-over-year), but everybody knew it was coming, guaranteed by $145 oil. However, offsetting CPI concern was Federal Reserve Chair Ben Bernanke’s grim testimony, pushing “below-trend growth” off into 2010; and a mere 0.1 percent gain in June retail sales — that at the high point of rebate checks, done now.

The cause of the 10-year spike from 3.8 percent to 4.07 percent was this strange chain: Early-week news of rapidly weakening Euro and Asian economies at last knocked oil into a three-day drop to $130. That news jangled the stock market — the Irish Setter of finance — into an ear- and tongue-flapping, eye-bulging race to buy. As soon as the fear of 1987 left stocks, so did the frightened bid for bonds, and up went T-rates.

Fair enough: Falling oil trumps a sinking globe. For the moment.

The mortgage story is different and separate.

In normal times, from the mid-’80s forward, retail low-fee Fannie mortgages were available at about 1.6 percent above the 10-year T-note, give or take 10 basis points. Mortgages today should be 5.75 percent, tops, at that level a help to ARM escapers, refiers of all kinds, and buyers of resale homes and foreclosures. Instead, since January the market has repeatedly traded 2.75 percent over the 10-year, a terrible burden on housing.

I have argued since last year that this spread had nothing to do with Fannie/Freddie credit fear, because the Ginnie spread was just as wide (Ginnies have been “full faith and credit” for 40 years). Instead, the spread is the best indication of the insolvency of the financial system.

If you’re MegaBanc or WhiteShoe Securities, and you’ve lost your capital, and the market thinks it unwise to give you any more, the ONLY way to improve your capital ratio is to shrink your assets. Sell! You have to keep some cash and cash-like Treasurys. Of course, you dare not try to sell the mountain of IOU-crap you created and hold, and are trying desperately to blame on subprime mortgages. That leaves high-quality MBS as the only assets you can sell without a loss.

Add to that: It’s not just MegaBanc and WhiteShoe … it is every single big institution trying to downsize simultaneously. Constant MBS selling has overwhelmed the modest buying by Fannie and Freddie, mutual funds and non-leveraged investors, and crowded out mortgage borrowers.

Meanwhile, the Wall Street Journal editorial crew, Kudlow’s Twits at CNBC and dozens of serious blogs insist that the private sector is perfectly able to provide mortgages, and that Fannie and Freddie should disband. Sophomoric, juvenile, irresponsible, puerile, ignorant … the private sector at work? Ask somebody for a fixed-rate jumbo quote, and then ask how the top-end 20 percent of housing will survive with 8.25 percent money — if anybody qualifies.

After the FDIC seizure of IndyMac (which by itself may consume 15 percent of the FDIC’s cash), FDIC head Sheila Bair observed, “The housing crisis … is no longer confined to states that once had go-go markets,” asking for more “pro-active intervention.” Her thinking still runs to finding ways to keep financially failed households in their homes.

Won’t work. We must help buyers. She is correct about nationally deteriorating housing (Seattle the new poster child, good economy and all), guaranteed by mortgage starvation. The only way to housing recovery is to stop the financial-institution implosion, and that means federal injection of capital and bad-asset extraction.

Lou Barnes is a mortgage broker and nationally syndicated columnist based in Boulder, Colo. He can be reached at lbarnes@boulderwest.com.