Mortgage Market Week in Review

Here we are on Friday again and it’s time to take another look at what’s going on in the mortgage markets. This week we’re going to talk about two economic reports and two big question marks.

First the economic reports from the week:
1. The Index of Leading Economic Indicators came out and it was down quite substantially. What is that index about? Basically it’s the conference board’s way of looking at what they think the economy is going to look like going forward. That’s why it’s called “Leading” rather than most reports that are essentially reporting what happened. This looks at what they think is going to happen based on trends and such. The fact that it’s way down doesn’t bode well for an economic recovery any time soon. It doesn’t specifically mean that we’ll have (or are in) a recession, but it does mean that things aren’t pretty.
2. The National Association of Home Builders reported that builder confidence came in for August at a record low. Gee, for any of you who read this who are a builder, know a builder, or work with one, it’s probably no surprise at all. We’re going through a fundamental shift in the building capacity that is needed in this country and the weeding out that is going to (and is) happening is not a fun thing by any means. Whether is was building, lending, or real estate sales, the bubble allowed way more people to get into the businesses than what the overall health and growth levels could handle. That’s an ongoing readjustment that needs to continue before we can hit bottom and go up from there.

Now for the two question marks. Actually, it’s one question about two companies. What’s the real story behind Fannie Mae and Freddie Mac? I’ll make a couple of points to tell you what my take on them is:
1. As “quasi governmental” institutions, Fannie and Freddie have been able to borrow money at rates that are better than what other companies can borrow money at. That’s because of the implicit backing of the US government.
2. Many foreign countries have invested a lot of money in Fannie and Freddie because of the guaranteed safety that was implicit in it all.
3. Fannie and Freddie have experienced some substantial losses over the last period of time. I’m talking numbers with lots of zeroes to the left of the decimal point.
4. The markets got spooked enough by those losses that the government had to pass legislation which gave the Treasury the authority to step in and bailout Fannie and Freddie if necessary.
5. Paulson (Treasury Secretary) has maintained consistently that Fannie and Freddie aren’t in need of a bailout and that he doesn’t intend to exercise the bailout provisions. The baoilout provisions are there to calm the markets. Sort of like a sprinkler system that is designed to put out a fire IF a fire starts.
6. According to what their government regulators require, it appears that Fannie Mae and Freddie Mac are adequately capitalized (meaning they have enough cash to keep the doors open) for now.
7. There are a lot of comparisons between the Bear Stearns “bailout” earlier this year and the Fannie and Freddie issue. That has prompted a lot of shareholders in both companies to be concerned that if the US government does have to institute a bailout, their shares would be worthless or close to that. From what I’ve heard, Bear Stearns sold for $10 a share and a year before it was at $123 a share, about a 95% drop. Fannie and Freddie are down about 90%. Hmmm….
8. There’s a big difference between the stock value of Fannie and Freddie and the safety of their debt. The safety and soundness of their debt is not the issue right now.

So what do I make of this whole issue? A couple of thoughts:
1. I think that eventually the government is going to have to nationalize Fannie and Freddie. If not because of financial reasons, then because of the negative effects that the uncertainty is having on the financial markets and the other financial firms. The entire credit market is very wobbly right now and until we have some stability some where, we aren’t going to see the markets calm down.
2. I read a report that quoted the CEO of Fannie Mae saying that their current business was making them plenty of money, it was the old business (loans from 2007 and before) that were the problem. Well, a couple of thoughts on that: a) It’s not usually the first 6 months when people have problems with their mortgage, so claiming that they are making money on that business is maybe a bit premature? b) If new business is only 15% of their “book of business” then that’s not that big of a deal either.
3. I feel that if the US (meaning you and me) have to step in and buy Fannie and Freddie, then it’s frankly quite appropriate that the shareholders don’t get hardly anything from their stock holdings. I also believe that if that happens, we should have a massive restructuring of the upper management of the two entities. According to one report, the CEO of Freddie Mac made $20,000,000 last year. That’s 100 times what the President of the United States makes and that’s way too much for a government entity.
4. Am I concerned that Fannie and Freddie are going to stop buying mortgages? No I’m not. For two reasons: 1) The housing market is too dependent on keeping mortgage money flowing and the economy is too dependent on keeping the housing market out of the dungeon (it might be in the basement but not the dungeon!) 2) With all of the foreign entities that have bought into Fannie and Freddie, it would be geopolitical suicide to stick China and others with billions in bad debt.
5. I also feel that it would be important to put a plan in place soon that would eventually (maybe a 10 year plan) return the mortgage market from being a nationalized “thing” to totally private.

So, in a nutshell, I believe that those who have good credit, a downpayment, and sufficient verifiable income will still be able to get financed. I do believe that because of all of this, even if the market would normally see rates drop, we won’t see that. I’m feeling pretty convinced that credit will be more expensive next year than it is this year.

Until next week…..

Tom Vanderwell