More WSJ on USG and Housing

From the WSJ:

Right now, housing remains on government life support. Treasury-backed entities are guaranteeing about 85% of new mortgages, while the Fed buys 80% of the securities into which these taxpayer-backed mortgages are packaged.
The optimistic take is that this support, though large, will shrink when market forces regain confidence. But there is a darker possible outcome: The emergency assistance is entrenching a system in which the taxpayer takes the default risk on most mortgages, while a small number of large banks get a larger share of the fee revenue from originating and servicing mortgages.

Market forces cannot hope to exert themselves when the risk/reward calculation is so low. Interest rates compensate for risk but spreads between treasuries are at all time lows and overall rates are at all time lows. Banks would make market rate loans but with the Fed distorting the market with its purchases they've actually become net sellers of mortgages instead. The market is saying that rates need to rise in order for them to lend but the USG doesn't want to hear that answer.

Wells Fargo CEO is very direct:

Despite the bust, conforming mortgages that qualify for government backing remain mispriced. That can be seen in the fact that banks have no desire to keep the most common mortgage on their books. Wells's chief executive, John Stumpf, recently said: "We're not putting on 30-year [fixed-rate] mortgages at these rates."

This housing market "bottom" being sold right now is predicated on ultra-low rates. These ultra-low rates are only possible because of the massive QE purchases by the Fed. How much longer will the purchases go on? Not only have the purchases reduced the spread over the 10 year note to very low levels, they have lowered overall rates as demand for MBS has wained and the normal MBS purchase money has gone to purchase other notes (the supposition is it went into Treasuries to wait out the market which reduces mortgage rates further).

Higher mortgage rates?

From Jeffrey Lacker regarding the Fed purchasing MBS:

With the economy leveling out and beginning to grow again later this year, and with bank reserve demand ebbing as financial conditions improve, I will be evaluating carefully whether we need or want the additional stimulus that purchasing the full amount authorized under our agency mortgage-backed securities purchase program would provide.

The Fed is a huge driver of demand for MBS for the people calling bottom on housing that bottom is precipitated on 5% interest rates. If a significant amount of demand is removed yields will definitely rise and housing prices will fall as a result.

Just some interesting tidbits and articles

Rates pretty much recovered from Wednesday massive sell off.. that inspired this look at Fridays rally from a MBS blogger:

Lots of mortgage brokers and bond traders are breathing a sigh of relief.

Sam Zell: Speeding up foreclosures would help housing market:

“Well, the inventory is going down,” Mr. Zell said, according to a transcript. “The affordability is going up. The government is making serious efforts to provide financing. And I think it’s slowly working. And the best thing that could happen is if we could accelerate all the foreclosures. Because I think they represent a drag on the market.”

I agree completely. Liquidating into a market with low rates, tax credit and prices still above historic norms certainly makes a lot of sense.

Wells Fargo CEO says California in 'financial ruin':

“The state of California is in financial ruin,” Stumpf told those attending a statewide microfinance lenders’ conference at Stanford University. “The budget deficit in California is staggering.”
...
“Today we’re charging off loans to people we should have made loans to,” said Stumpf, reiterating that the bank avoided many of the exotic mortgages offered by rivals.

The main brunt of the State, county and local cuts have yet to be felt. Usually governments are expanding during downturns to be the "spender of last resort". But this time there is no rainy day fund or another till to tap. I also enjoyed the second quote, the fact that a CEO of a major institution can talk so flippantly about giving out money to people who could never hope to pay it back is just amazing to me.

HUD came out with the guidance for using the tax credit during the purchase of a home instead of after.

The great news here is that the tax credit can't be used as a source for the initial 3.5% down payment. It can be used for closing costs or additional down payment but it does not allow for 100% financing. Its effect will be marginal on the market.

Who would ever invest in mortgage bonds again?

Bloomberg had a great article regarding how mortgage bond investors are getting a raw deal and having existing contracts modified against their will by the government:

Bondholders are preparing for a fight over legislation approved last month by the House of Representatives that would shield companies that collect homeowners’ payments from lawsuits over modified mortgages, even if new terms harm investors. The government’s actions may increase borrowing costs because creditors would demand higher returns to compensate for the risk that once-sacrosanct investment terms can be changed, they say.

“Certainly some greater amount of loans should be restructured, but it is a fallacy to think that policymakers can selectively abrogate contracts without affecting future investor behavior,” Frey, chief executive officer of Greenwich Financial, a mortgage-bond broker and investor in Greenwich, Connecticut, said in an e-mail. “We are actively exploring strategies with major investors to protect their rights.”

A big deal is being made about keeping people in their homes at all costs. But those costs are coming from both the taxpayers and bond holders, who the last I checked are people too. It would be one thing if you invested in lower rated tranches and got wiped out, or poorly structured finance products which didn't adjust for risks properly. But these are people who aren't complaining about the products they bought, they are complaining that the government is stepping in to change the rules of the game after the contract has been signed. Why anyone would ever put money into mortgage bonds again is beyond me. How do you model governments ability to redefine anything they want? This is a huge line being crossed.

By “allocating losses to some place that’s not expecting it,” including state pension plans, college endowments and life insurers, those investors will demand more return to hold mortgage debt without government backing, if they buy at all, said Amherst CEO Sean Dobson, whose firm trades home-loan bonds and advises clients about the securities. “Capital’s going to cost a lot more for a long time.”

If you are in a senior rated tranche you want liquidation over reduced cash flow, you get paid off first with the proceeds when the mortgage is liquidated but with reduced cash flows it spreads the loss more evenly across the tranches. The administration is saying that the servicers can reduce cash flow over liquidate and they will protect the servicers from the lawsuit. The whole article is excellent and I highly suggest reading the whole thing. I made sure none (fine, the smallest bit of my smallest bond fund holds a minor percentage of mortgage bonds) of my investments held mortgage bonds. The risk/reward isn't there and I don't want my money supporting the mortgage market.