Banks Give Up Hopes of Hikes, Plow Into Long Dated Treasuries and Mortgage-Backed Securities

Banks have become convinced the Fed simply isn't going to hike. So instead of waiting any longer, large banks like Wells Fargo are plowing billions of dollars into longer dated treasuries and agencies.

Simply put, Big US Banks Lose Patience With the Fed

In the years since the crisis the banks have grown used to grappling with higher costs and subdued demand for credit, while keeping plenty of cash and cash-like instruments on hand in the hope of benefiting from an uptick in short-term rates.

But, after the decision from the US Federal Reserve to keep its target overnight rate on hold this month, more lenders are taking their cue from Wells Fargo, the biggest bank in the world by market capitalisation, said analysts.

Over the past year the San Francisco-based bank has run down its cash and short-term investments to buy longer-term assets, on the basis that rates will stay “lower for longer”, according to John Shrewsberry, chief financial officer.

That conviction is now catching, said Jason Goldberg, an analyst at Barclays, which recently hosted representatives from about 150 banks at a conference in New York. “The consensus was: give up on the Fed,” said Mr Goldberg.

n the second quarter, noted Barclays, about half of banks under its coverage reduced their sensitivity to rate rises by converting cash to higher-yielding assets — the highest proportion for more than four years.

Wells Fargo added $50bn of securities to its held-to-maturity investment portfolio over the year to June, according to public filings, with much of it going to Treasuries and bonds issued by Fannie Mae and Freddie Mac, the government-backed mortgage companies. “We’re earning today rather than maintaining all of that sensitivity for the future,” said Mr Shrewsberry, during the bank’s second-quarter results presentation.

“Bankers are starting to say, we can’t run these institutions based on hope for higher rates, so let’s figure out what we can do,” said Fred Cannon, global director of research at Keefe, Bruyette & Woods.

Futures Still Suggest March as First Hike

A quick check on CME FedWatch still shows the first hike in March of 2016. Based on futures prices, it will be an eighth of a point hike at that.

Mike "Mish" Shedlock

Housing Regulator Wants to Throw the Drowning Poor an Anchor; Mish Alternative Proposal

Now that home prices have recovered from the Great Financial Crisis to the point of being way overvalued again in many areas, a Housing Regulator Targets More Support for Poor Borrowers.

The regulator for U.S. housing finance giants Fannie Mae and Freddie Mac told the two firms on Wednesday to provide more support to low-income Americans taking out mortgages and refinancing home loans.

The Federal Housing Finance Agency released goals for the two government-controlled firms for 2015-2017 that would advance agency chief Mel Watt's aim to widen access to housing credit.

The rules direct Fannie Mae and Freddie Mac to expand the number of loans they back for low-income families to 24 percent of the their purchases of single-family home mortgages over the period, up from a target of 23 percent in 2014.

FHFA also asked each firm to make mortgages refinanced by low-income families a bigger share of their refinancing purchases, and to increase the number of mortgages they buy for multi-family properties each year.

Throw the Poor an Anchor

The increases are small. But they are also symbolic of the same attitudes that got us in trouble before. It would have made far more sense to widen availability in 2009 when homes were more  affordable.

Now after prices have recovered, regulators again want to "do something" to make housing more affordable. But the more support they give, the more people are encouraged to buy beyond their means, and the more prices rise.

We don't need regulators of this nature. Nor do we need a Fed price-fixing interest rates. Both contributed to the housing boom-bust and both are back at it again.

No one learned a damn thing.

Mish Proposal

1. Shut down Fannie Mae
2. Shut down Freddie Mac
3. Shut down the FHA
4. Get the hell out of Ownership Society promotion
5. End all affordable housing programs
6. Let free market forces regulate the market

Mike "Mish" Shedlock

New Housing Crisis in the Making? If So, What's the Solution?

Home ownership rates are sinking and demographics are part of the reason. But does that constitute a new housing crisis?



The Wall Street Journal writer Nick Timiraos makes the case in New Housing Crisis Looms as Fewer Renters Can Afford to Own.

Last decade’s housing crisis has given way to a new one in which many families lack the incomes or savings needed to buy homes, creating a surge of renters and a shortage of affordable housing.

The latest crisis looks very different from the subprime mania of the early 2000s, but it does share one trait: Policy makers in Washington appear either unaware or unwilling to do much about it.

The U.S. homeownership rate is now below where it stood 20 years ago when President Bill Clinton launched a national campaign to encourage more Americans to buy homes. Conventional wisdom says the rate, now at 63.7%, is leveling off to where it was for decades before the housing-market peak.

But this is probably wrong, according to research from the Urban Institute, which predicts homeownership will continue to slip for at least the next 15 years.

Demographics tell the story. The Urban Institute researchers predict that more than 3 in 4 new households this decade, and 7 of 8 in the next, will be formed by minorities. These new households—nearly half of which will be Hispanic—have lower incomes, less wealth and lower homeownership rates than the U.S. average.

The declines reflect a surge of new renter households, which is boosting rents. Together with tougher mortgage-qualification rules, this will leave households stuck between homes they can’t qualify to purchase and rentals they can’t afford, says Ron Terwilliger, who spent two decades running Trammell Crow Residential, one of the nation’s largest apartment developers.

As rental households devote a greater share of their income to rent, families could face greater challenges in saving for a down payment. This could restrain a housing market that has failed to provide any real lift to the economy in the current expansion.

What’s to be done? Given budget pressures, it may not be realistic to expect the government to spend any more money on housing than it already does. Thus, the focus now should be on reallocating what is already committed, says Mr. Terwilliger, a Republican, who this month will formally launch a foundation designed to start these conversations. His goal is legislation after the 2016 election that realigns housing policy with the shifting dynamics.

Breaks for Apartment Builders

Given that Terwilliger spent two decades as one of the nation's largest apartment developers the answer should be easy to figure out. He wants to end tax breaks for home ownership to subsidize new home owners and "free up funds for the rental side".

His complaint: 75% of the housing tax breaks go to the top 20% of individuals. That is hardly shocking given the top 20% buy the most expensive homes and therefore pay the most in interest.

Timiraos, buys all Terwilliger's nonsense hook line and sinker, finishing the WSJ article with "Politically, none of this will be easy . Some will say it’s a zero-sum game—helping renters at the expense of owners. Not so, says Mr. Terwilliger. If renters can’t ever become homeowners, who will buy those homes when today’s homeowners need to sell?"

Housing Crisis Past and Present

The 2015 housing crisis was caused the same way as the one in 2007: Interference by the Fed, by Congress, by local officials wanting to create affordable housing.

Terwilliger wants a combination of affordable housing and affordable renting. Lovely.

Driving up home ownership rates is guaranteed to do one thing: drive up prices.

Fannie Mae, Freddie Mac, and hundreds of other government programs culminating with president Bush's "Ownership Society" all contributed to make housing unaffordable.

The government has no business promoting one form of living over another.

Self-Correcting Problem

Terwilliger ends with the question "If renters can’t ever become homeowners, who will buy those homes when today’s homeowners need to sell?"

The answer should be obvious: Prices will fall until there is a pool of buyers!

In the wake of the great financial crisis, home prices actually fell to the point of being affordable. Few seemed happy with the result. The Fed wanted to prevent deflation and in the greatest financial experiment in history unleashed round after round of QE.

Asset prices recovered, but wages didn't. As a result, homes are once again unaffordable.

Does Terwilliger want affordable housing or not?

If government and the Fed got out of the way, there would be no problem. Instead, Terwilliger wants the government to "do something".

I suggest the government and the Fed have done far too much already.

Solution is Undoing

Instead of promoting something, a process that has failed every time, how about undoing everything that contributed to the mess.

My proposal

• Eliminate Fannie Mae
• Eliminate Freddie Mac
• Eliminate the FHA
• Eliminate rent controls
• Eliminate itemized deductions and replace with a flat tax

That's the real solution to the problem, not more self-serving affordable housing nonsense from people with a vested interest in promoting something for their own benefit.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

MarketWatch Infomercial: Can Millennials Finally Afford a Home?

The Outside the Box MarketWatch Opinion of Damian Maldonado is Millennials Can Finally Afford Homes with New Mortgage Rules.

Let's start with a look at the new rules.

New Rules

1. The administration earlier this month cut the premium that borrowers with a Federal Housing Administration loan must pay for mortgage insurance to 0.85% from 1.35%. The half a percentage point reduction will reduce the cost of the average FHA loan by about $1,000 per year.
2. Fannie Mae and Freddie Mac last month dropped the minimum down payment to 3% from 5% on some of its mortgages. FHA requires a 3.5% down payment.
3. Grant programs, such as CHFA in Colorado, allow home buyers to purchase a home with as low as a $1,000 down payment.

Hoop Jumping

Maldonado jumps through all sorts of hoops to justify the new rules, pretending that "new regulations, should stop the problems that led to the subprime mortgage crisis".

He concludes "Perhaps this will be the year this generation will leave their expensive rentals, or their parents’ basements, and move into their own homes and live the American Dream."

I propose that after this relentless rally in home prices, the above "new rules" are too risky. Low down payments would have made more sense actually at the bottom of the market, when standards tightened.

This is typical regulatory BS, lowering lending standards when they should be tightened, and tightening them when arguably they could be lowered.

The cure in this case is to get rid of Fannnie Mae, Freddie Mac, and the FHA, all useless organizations that have done nothing but raise the cost of housing by promoting houses as the "American Dream".

Nonetheless, I offer this musical tribute.


Link if above video does not play: Andy Williams - The Impossible Dream (The Quest)

Questions

Before you get too teary-eyed over the American dream, let's investigate two questions.

Question Number 1: Who is Damian Maldonado?

Answer Number 1: Damian Maldonado is CEO and co-founder of national mortgage lender American Financing.

Question Number 2: Why the hell is MarketWatch running infomercials for American Financing?

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

Helping "Qualified" Buyers: Fannie, Freddie Detail 3%-Down Payment Mortgage Program

Now that home prices have recovered and homes are not the bargain they were four years ago, it is fitting the parasites once again want to make homes "affordable" to the masses with low-down payment options.

Please consider Fannie Mae, Freddie Mac detail plans for 3% down-payment mortgages.

Housing finance giants Fannie Mae and Freddie Mac on Monday detailed plans to once again back mortgages with down payments as low as 3%, saying the move to make home ownership more accessible contains safeguards to protect against abuses that led to the subprime housing market crash.

“Our goal is to help additional qualified borrowers gain access to mortgages,” said Andrew Bon Salle, executive vice president for single family underwriting, pricing and capital markets at Fannie Mae.

Officials said the program was designed to help credit-worthy borrowers, particularly those with low or moderate incomes, who can demonstrate the ability to repay a mortgage but lack the money needed for at least a 5% down payment.

Freddie Mac will limit its program, called Home Possible Advantage, to mortgages for first-time homebuyers. Borrowers must participate in a homebuyer education and counseling program before receiving the loan and will have to pay for private mortgage insurance.

Fannie Mae's program will be available to anyone who has not owned a primary residence for three years. Private mortgage insurance will be required but counseling and education will not.

Helping "Qualified" Buyers

Notice the statements about helping "qualified borrowers".

If you lower the qualifications to zero, everyone qualifies by definition. But is that a "help" or a debt-trap in waiting?

My Take

If you cannot afford to put 10% down on a home, then you can't afford the home.

I side with House Financial Services Committee Chairman Jeb Hensarling (R-Texas) who stated: "Such loans are inherently risky because the borrower has almost no financial cushion against a personal or economic downturn, vastly increasing the likelihood they will walk away from the loan once it gets significantly underwater."

Low down payment loans are "an invitation by government for industry to return to slipshod and dangerous practices that caused the mortgage meltdown in the first place and wrecked our economy."

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

Post-Foreclosure Hell: Garnished Wages, Seized Assets, Deficiency Judgments

In 2009 and 2010 "Walking Away" was the rage. (skip the adds and scroll down to my list of articles).

Back then, I frequently cautioned Before Walking Away Consult An Attorney, advice repeated in nearly every reference to the practice.

Walking away without declaring bankruptcy, especially with a recourse mortgage was always a dangerous practice.

Moreover, law is complicated because rules vary from state to state, and non-recourse loans often became recourse loans if refinanced.

Post-Foreclosure Hell

Unfortunately, Post-Foreclosure Hell is the sorry result for those who did not consult an attorney.

Many thousands of Americans who lost their homes in the housing bust, but have since begun to rebuild their finances, are suddenly facing a new foreclosure nightmare: debt collectors are chasing them down for the money they still owe by freezing their bank accounts, garnishing their wages and seizing their assets.

By now, banks have usually sold the houses. But the proceeds of those sales were often not enough to cover the amount of the loan, plus penalties, legal bills and fees. The two big government-controlled housing finance companies, Fannie Mae and Freddie Mac, as well as other mortgage players, are increasingly pressing borrowers to pay whatever they still owe on mortgages they defaulted on years ago.

Using a legal tool known as a "deficiency judgment," lenders can ensure that borrowers are haunted by these zombie-like debts for years, and sometimes decades, to come.

The most aggressive among the debt pursuers is Fannie Mae. Of the 595,128 foreclosures Fannie Mae was involved in – either through owning or guaranteeing the loans - from January 2010 through June 2012, it referred 293,134 to debt collectors for possible pursuit of deficiency judgments, according to a 2013 report by the Inspector General for the agency’s regulator, the Federal Housing Finance Agency.

It is unclear how many of the loans that get sent to debt collectors actually get deficiency judgments, but the IG urged the FHFA to direct Fannie Mae, along with Freddie Mac, to pursue more of them from the people who could repay them.

The article notes that Florida is one of the more aggressive states in pursuing "deficiency judgments". For example ...

Bank teller Danell Huthsing broke up with her boyfriend and moved out of the concrete bungalow they shared in Jacksonville, Florida. Her name was on the mortgage even after she moved out, and when her boyfriend defaulted on the loan, her name was on the foreclosure papers, too.

On July 5, a process server showed up on her doorstep with a lawsuit demanding $91,000 for the portion of her mortgage that was still unpaid after the home was foreclosed and sold. If she loses, the debt collector that filed the suit can freeze her bank account, garnish up to 25 percent of her wages, and seize her paid-off 2005 Honda Accord.

I specifically spotlighted Florida in Before Walking Away Consult An Attorney.

But it's not just Florida.

Reuters reports "Once financial institutions secure a judgment, they can sometimes have years to collect on the claim. In Maryland, for example, they have as long as 36 years to chase people down for the debt. Financial institutions can charge post-judgment interest of an estimated 4.75 percent a year on the remaining balance until the statute of limitation runs out, which can drive people deeper into debt."

Hundreds of thousands of people will soon be in extremely hot water because they failed to seek advice from an attorney, advice which may have cost only a couple hundred dollars in 2009.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

Goldman Sachs President Inadvertently Explains Why Cantor Lost; Reflections on the Bush Years

On Wednesday, Eric Cantor resigned as House Majority Leader following his shocking primary loss to Tea Party candidate Dave Brat.

A majority leader has never in history lost a primary election.

Shock waves reverberated in both Republican and Democratic camps. Most wonder how it happened. Explanations abound. CNN gives 7 Reasons Eric Cantor Lost.

I find those explanations lacking.

Instead, I propose people are fed up with Washington. But that has been the case for years if not decades. So why such a shocking upset now?

Gary Cohn Explains

Gary Cohn, President and COO of Goldman Sachs, inadvertently answers the question "why now?"  in the following Bloomberg video.   



"I think Eric has been a great leader. He's been a great public servant. And I think we've all enjoyed having Eric in the Congress," said Cohn.

Indeed! Wall Street enjoyed having Cantor in office, too much so. But what about the average Joe?

Cantor's Arrogance

Cantor's arrogance, combined with the right message, was all it took.

Dave Brat explains in an interview with Sean Hannity: GOP "Paying Too Much Attention To Wall Street And Not Enough To Main Street".

SEAN HANNITY: What do you attribute this big win tonight to?

DAVE BRAT , REPUBLICAN NOMINEE for VA-7: It’s pretty much been in my stump speech, and it basically just lays out… If you go door to door knocking, the American people know this country is headed in the wrong direction: the debt, the deficits, the economic growth is terrible. The regulatory burden is terrible. And the representation in D.C. won’t address those major issues. And so, I think the people are ready for some major changes in this country, and it’s a miracle.

I ran on Republican principles. We have this Republican creed in Virginia and the only problem with the Republican principles is no one is following them.

The first one is commitment to free markets. We don’t have any free markets in this country any more. Then equal treatment under the law, fiscal responsibility, constitutional adherence, peace through strong defense and faith in god and strong moral fiber. That’s what I ran on: The Republican creed.

Some of this goes back to constitutional principles, and everybody wants the federal government to solve every problem in their life. So part of the issue is, on some of these issues, we’ve got to look at these issues in the mirror. The cultural issues, that’s not due to politicians. Our educational system, everyone thinks can be solved with spending infinite money on it, a lot of it just comes down to personal responsibility and discipline

The Republican party has been paying too much attention to Wall Street and not enough to Main Street. The American people want to take the country back and what motivated the race for me was after the financial circumstance we had Fannie [Mae] and Freddie [Mac] collapse. I thought surely our political leaders, we're on our knees economically, we'll learn some lessons and get it right and they didn't. We're still roughly in the same mess.

Reflections on the Bush Years

What do Republicans have to show for the Bush years? A Real Clear Politics article explains.

Analysts need to understand that the Republican base is furious with the Republican establishment, especially over the Bush years.  From the point of view of conservatives I’ve spoken with, the early- to mid-2000s look like this: Voters gave Republicans control of Congress and the presidency for the longest stretch since the 1920s.

And what do Republicans have to show for it? Temporary tax cuts, No Child Left Behind, the Medicare prescription drug benefit, a new Cabinet department, increased federal spending, TARP, and repeated attempts at immigration reform.  Basically, despite a historic opportunity to shrink government, almost everything that the GOP establishment achieved during that time moved the needle leftward on domestic policy. Probably the only unambiguous win for conservatives were the Roberts and Alito appointments to the Supreme Court; the former is viewed with suspicion today while the latter only came about after the base revolted against Harriet Miers.

The icing on the cake for conservatives is that these moves were justified through an argument that they were necessary to continue to win elections and take issues off the table for Democrats. Instead, Bush’s presidency was followed in 2008 by the most liberal Democratic presidency since Lyndon Johnson, accompanied by sizable Democratic House and Senate majorities.

You don’t have to sympathize with this view, but if you don’t understand it, you will never understand the Tea Party.

Good riddance to Cantor. He won't be missed. Boehner should step down as well.

Let's get some Republicans in Congress who truly believe in free markets, smaller government, and fiscal sanity. The current leadership has been pathetic.

Let's also elect a president willing to do more than pay lip service to free markets. My choice: Rand Paul.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

Treasury Yields Decline in Spite of Price Inflation; Mortgage Rates vs. Treasuries

Curve Watcher's Anonymous has its eye on the US treasury yield curve today.



click on chart for sharper image

Chart Symbols

• $TYX: 30-Year
• $TNX: 10-Year
• $FVX: 05-Year
• $IRX: 03-Month

Yields Decline Today



The above table of US Bond Yield changes from Bloomberg.

CPI Up - Treasury Yields Down

With the CPI up more than expected, and with food inflation averaging 3% annually over the last three months (see Food Prices Soar; CPI Posts Biggest Gain in 10 Months; Real Average Earnings Decline) one might have expected yields to rise.

Instead, yields fell. Why?

The US economy is slowing more than expected. Lately, economic surprises have been to the downside.

Mortgage Rates at 11-Month Low

Bloomberg reports Mortgage Rates Dropping With Bond Yields at 11-Month Low

A rally in the mortgage-bond market may send U.S. home-loan rates to the lowest in almost a year, bolstering a slowing real-estate recovery.

Yields on Fannie Mae securities that guide borrowing costs because they’re used to package new 30-year mortgages for sale fell 0.04 percentage point today to about 3.16 percent as of 1:50 p.m. in New York, according to a Bloomberg index. That would be the lowest closing level since yields reached a four-month low of 3.15 percent on Oct. 29, after they surged to as high as 3.81 percent in September.

The average rate offered on typical 30-year mortgages fell to a six-month low of 4.2 percent this week from a 2013 high of 4.58 percent in August, according to Freddie Mac surveys. Borrowing costs, which are driven by changes in lenders’ profit margins as well as bond yields, are up from a record low 3.31 percent in November 2012

Divergence Between Mortgage Rates and Treasuries

There can be leads and lags in mortgages vs. treasuries but generally they are in close sync.

30-year Mortgage Rate



Chart courtesy of Bankrate.

With home prices up and mortgage yields not dropping, home affordability is declining. Sales will follow. Expect household formation to stay in the gutter.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

Culture of Greed and Arrogance: Minutes Show Bank of England was Aware of Currency Rigging Eight Years Ago

Bank of England head Mark Carney faces a grilling from lawmakers tomorrow as Minutes Show Bank of England was Aware of Currency Rigging Eight Years Ago.

Bank of England Governor Mark Carney will face his toughest public testimony to date as he seeks to defend the integrity of an institution that’s become embroiled in the currency-manipulation scandal.

Lawmakers will grill Carney tomorrow after the BOE suspended an employee and released minutes of meetings showing officials knew of concerns the foreign-exchange market was being rigged almost eight years ago. The central bank said last week that an internal review has found no evidence so far that staff were involved in collusion.

It’s the second rigging scandal to hit the central bank following its entanglement in 2012 in the manipulation of the London interbank offered rate. Lawmakers criticized how it handled that affair, calling it naive.

“The statement on the internal review is only an early staging post in what is likely to develop into a very significant issue,” said Simon Hart, a lawyer at RPC LLP in London. “The statement left open as many questions as it answered. It was noticeably silent on what the Bank knew about other FX market participants.”

The testimony comes as regulators investigate allegations that traders at the world’s largest banks worked together to rig the $5.3 trillion-a-day foreign-exchange market. The U.S. Securities and Exchange Commission is investigating whether traders distorted prices for options and exchange-traded funds by rigging benchmark currency rates, according to two people with knowledge of the matter, Bloomberg News reported today.

More than 20 traders from banks including Deutsche Bank AG, Citigroup Inc. (C) and Barclays Plc (BARC) -- the three biggest currency traders, according to a May Euromoney survey -- have been fired, suspended or put on leave since Bloomberg News first reported in June that dealers said they shared information about client orders to manipulate foreign-exchange benchmark rates.

The suspended BOE employee, who hasn’t been named, is being investigated and “no decision has been taken on disciplinary action,” the central bank said on March 5.

According to minutes of meetings released alongside that statement, BOE officials knew of concerns the foreign-exchange market was being manipulated as early as July 2006, more than seven years before regulators opened formal probes. The minutes also show BOE officials discussed with traders concerns that currency benchmarks such as the WM/Reuters 4 p.m. London fix were being manipulated.

Foreign-exchange benchmarks like WM/Reuters are used to compute the day-to-day value of holdings and by index providers. Even small movements can affect the value of what Morningstar Inc. estimates is around $3.6 trillion in funds.

The allegations drag the BOE into another market-rigging scandal less than two years after it was criticized by politicians for failing to act on warnings that Libor was vulnerable to abuse.

Culture of Greed and Arrogance

Where are the criminal indictments? 20 people fired? Is this it? Are we to presume no one at the top of these organizations knew and approved of this rigging?

This is part of the overall culture of greed and arrogance fostered by central banks globally. No matter what the "too big to fail" banks do they are bailed out at taxpayer expense every time they get into trouble.

Bernanke stated his biggest mistake was letting Lehman fail. The records show Lehman, Citigroup, Bank of America, AIG, Fannie Mae, Freddie Mac and countless other financial institution "did" fail.

It was not a matter of "letting them fail" they already did. It was a matter of bailing them out, and Bernanke wanted to bail more of them out, including Lehman.

On top of it all, no one was held criminally responsible for the collapse in mortgage-backed securities, no one was held responsible in LIBOR rigging, no one has been held responsible for anything to date, and no one will be held responsible for currency rigging either.

To date, all we have seen is a series of fines coupled with high-fives when executives escaped serious charges no matter what any of them did.

Expect more "EH5s" executive high-fives when this too is swept under the rug.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

When Will the Fed Hike Part II - Discussion of Debt Duration - Communication the Only Tool Left

In response to When Will Interest on US National Debt Exceed $1 Trillion some readers objected stating "things are different now". I had to laugh at that.

Others stated that I ignored duration. I did, but I did post results at various interest rates, one of them optimistically assuming rates would stay at current levels.

For ease in discussion, here is the chart again, with my original "fed is in a box" claim. An analysis of "debt duration follows".

Projected Interest at Various Rates

Hidden Agenda

The current blended rate of interest on the national debt is a mere 2.4% according to the CBO.

The "optimistic" projection of $668 billion assumes the rate will stay below 3.1% through 2020.

Shifting Goalposts

Really think the Fed is going to hike? They know they can't, and the Fed is disingenuous as to why.

A year ago the Fed was discussing 6.5% as a trigger point.

In December, the Wall Street Journal noted the Fed’s Shifting Unemployment Guideposts

Now, in the wake of a massive collapse in the labor force in which unemployment rate just dropped to 6.7% it's easy to understand why the goalposts shifted.

The Fed pretends its interest rate policy is about a dual mandate of jobs and GDP growth.

The above charts show the real reason for the shift: the Fed is in a box of its own making and it has no freaking idea how to get out of the box.

Duration Weighted Average

Reader "Paul" pointed me to the OMB Fiscal Year 2012 Q1 Report.

There are lots of interesting charts in the report, but especially note the chart on page 15, shown below (annotations in red are mine).



Duration is expected to rise from from about 67 months (5.58 years) to about 78 months (6.5 years).

Current Trends

According to Bloomberg, yields are rising sharply on the long end.



click on chart for sharper image

Yield on the 5-Year note is currently 1.59%. A year ago it was 0.78%. Yield on the 10-Year note is 2.83%. A year ago it was 1.87%.

Think the Fed can afford to let interest rates rise further?

I didn't and still don't.

Even though the average duration is now 5.5 years, The Fed Owns 40% Of All Treasuries Over 5 Years In Maturity.

According to Forbes (see above link), during 4 years of QE, QE1, QE2, and QE3, the Fed accumulated 36% of all Treasury securities between 5 years and 10 years in maturity plus 40% of those government bonds over 10 years in maturity, as well as 25% of all the mortgage backed securities not owned by Fannie Mae and Freddie Mac.

What's the Fed going to do now? Accumulate all the notes and bonds? While buying less of them? The math doesn't quite work does it?

Communication the Only "Tool" Left

The Fed hopes to stabilize rates via communication, hoping to convince everyone of three things

1. The economy is strengthening
2. Regardless of the strengthening economy, the Fed won't hike rates
3. Long-term rates should not rise

Three Problems

1. If the economy is strengthening, interest rates should rise
2. If the economy is headed into a recession or even weakening, then equity prices and corporate bonds are grossly overpriced
3. The Fed is not really in control

Exit Strategy

So what is the Fed's exit strategy?

The Fed really doesn't have one, and that is the reason for all this meaningless communication from various Fed governors (frequently in contradiction with each other).

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

Expect Higher Mortgage Loan Rates in 2014; New "QM" Rules May Mean Less Lending

In regards to Average 30-Year Mortgage Rate Hits 4.47% (Not Counting Fees); Affordability Check Michael Becker at WCS Funding Group just pinged me with his thoughts on why mortgage rates will go up in 2014 even if treasury rates stay flat.

Michael writes ...

Hey Mish,

I was just reading your post on rising mortgage rates and I can confirm that mortgage rates are approaching the highs reached earlier this year in early September.

Additionally, they are set to go higher in 2014 regardless of whether or not the yield on the 10 year Treasury continues to rise.  The agency that oversees Fannie and Freddie, the FHFA, has announced another increase in their guarantee fees or g-fees and increases in their loan-level price adjustments or LLPA.

The former are charges to lenders for guaranteeing mortgage backed securities and the latter are risk based adjustments to pricing on mortgages. The new increases in both will be charged to borrowers and will increase mortgage rates as much as .375% for many borrowers.

The FHFA has stated the reason for these increases is to encourage private money, non-Fannie or Freddie, to return to the mortgage market.  While that is a good idea and many in the industry would like to see that happen, it's hard to see that happening with the new Qualified Mortgage (QM) rules issued by the Consumer Finance Protection Bureau CFPB starting on January 10, 2014.

Without going into much detail these new rules will restrict lending in the future and I believe discourage private money from entering the mortgage market.

So with rising rates, increased fees making rates even higher than they would be otherwise, and mortgage credit being further restricted it's hard to see how real estate will continue to recover in 2014 as affordability decreases.

Regards,

Michael Becker
WCS Funding Grp.

New "Qualified Mortgage" Rules May Mean Less Lending

The Chicago Tribune reports It'll take time to see effect of new mortgage rules

New regulations governing home loans take effect Jan. 10, but it's likely to take a few months to see how much they really alter a prospective borrower's ability to get a mortgage.

Combined with other tweaks made in the past few months, the changes will mean new terminology and revamped paperwork for lenders to understand and then explain to borrowers in 2014. They also could lead to less lending, experts say.

The goal of the new mortgage rules from the Consumer Financial Protection Bureau is to better protect borrowers from the lax underwriting that wreaked havoc on people and the housing market. The regulations are designed to ensure a borrower's "ability to repay" a mortgage while also offering lenders protection from borrower lawsuits so long as they make safer so-called qualified mortgages.

"I think the mainstream borrower is going to be OK," said Bob Walters, chief economist at Quicken Loans. "Lenders will go through a period of adjustment. There will be some upset in the first half of the year as people digest the rules."

The borrowers most likely to be affected are those on the lower and higher ends of the lending spectrum.

The rules bar some loan products that all but disappeared during the housing crisis — interest-only loans, balloon-payment loans and mortgages with terms that extend past 30 years — from being considered qualified mortgages.

Under another part of the rule, a borrower's overall debt can make up no more than 43 percent of gross income. The effect of that provision will be muted, however, because, at least temporarily, it does not apply to loans that will be purchased by Fannie Mae or Freddie Mac or backed by the Federal Housing Administration. Those agencies continue to account for the overwhelming majority of new mortgage loans.

However, Fannie Mae, Freddie Mac and the FHA all are looking to limit their exposure, and thereby the taxpayer's exposure, in the housing market.

The FHA last month decreased its maximum loan limits for 2014. The Federal Housing Finance Agency, which regulates Fannie Mae and Freddie Mac, this month said it was considering reducing the maximum loan size it may buy.

Housing experts say one effect of that rule could be that consumers looking for loans in the $100,000 to $150,000 range may find fewer lenders from which to choose. That's because a loan has to go through the same amount of paperwork and underwriting, regardless of whether it's for $100,000 or $400,000.

"Lenders may not do those loans," said Ken Perlmutter, president of Perl Mortgage. "It's just as much work, and you can't change the fees."

That 3 percent cap also could affect a borrower's ability to buy down their interest rate by paying points upfront, as well as restrict the ability of people with lower incomes and risky credit, who typically have paid higher fees, to receive a mortgage.

Jumbo mortgages also could become harder to receive because they too must meet the 43 percent debt-to-income ratio to be considered a qualified mortgage. However, Perlmutter said he already is seeing investors step in who are interested in purchasing mortgages that fall outside the government's regulations.

2014 Summary

1. More Consumer Protections
2. Loans Harder to Get 
3. More Fees
4. All things equal, 0.375 Percentage Point Hike in Mortgage Rates

Actual amount of increase or decrease of mortgage loan rates in 2014 will depend on treasury rates, but the base assumption (if treasury yields remain unchanged) is a hike in mortgage rates of 0.375 percentage points, with some loans harder to get irrespective of rates.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

Average 30-Year Mortgage Rate Hits 4.47% (Not Counting Fees); Affordability Check

USA Today reports Average 30-year mortgage rate moves up to 4.47%

Mortgage buyer Freddie Mac said Thursday the rate on the 30-year loan increased to 4.47% from 4.42% last week. The average on the 15-year fixed loan rose to 3.51% from 3.43%.

A government report issued Wednesday showed that U.S. builders broke ground on homes in November at the fastest pace in more than five years, strong evidence that the housing recovery is accelerating despite higher mortgage rates.

Data from the National Association of Realtors released Thursday showed the number of people who bought existing homes last month declined for the third straight month as higher mortgage rates made home-buying more expensive.

To calculate average mortgage rates, Freddie Mac surveys lenders across the country on Monday through Wednesday each week. The average doesn't include extra fees, known as points, which most borrowers must pay to get the lowest rates. One point equals 1% of the loan amount.

The average fee for a 30-year mortgage was unchanged at 0.7 point. The fee for a 15-year loan declined to 0.6 point from 0.7 point.

Bankrate 30-Year Fixed Mortgages



Chart courtesy of bankrate.

10-Year Treasury Yield



Mortgage rates tend to follow the yield on 10-year treasuries. At 2.984% the 10-year treasury yield is as high as any time since mid-2011. Since mid-2012 the 10-year treasury yield is up from 1.394% in mid-2012, a rise of 159 basis points (1.59 percentage points).

Affordability Check

In December 2012, the 30-year fixed rate mortgage was 3.4% Today it is 4.52%, a rise of 1.12 percentage points.

Housing analysts point out that rates are low on a historical perspective, and they are correct. Nonetheless, a one percentage point rise in rates affects affordability by 10-11%.

Recall that a record number of Millennials, adults aged 18 to 32, put off household formation and stay at home to live with parents. See Kids Living in Basements a Drag on U.S. Services Spending

Each uptick in mortgage rates, even near "historic low rates", discourages household formation.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

Government About to Destroy American Mortgages Permanently Warns Dick Bove; Mish Says Nonsense

Citing Dick Bove, Yahoo!Finance reports Government About to Destroy American Mortgages Permanently.

Mortgages as we know them are going away in the next four years, warns Dick Bove, vice president of research at Rafferty Capital. Bove, one of the most widely-respected banking analysts in the world, is certain that will have devastating consequences for housing and the rest of the American economy.

The removal of the two most important players in American mortgages – the Federal National Mortgage Association ("Fannie Mae") and the Federal Home Loan Mortgage Corporation ("Freddie Mac") – threatens the very foundation of the American economy, according to Bove.

These two government-sponsored entities – along with the smaller Government National Mortgage Association ("Ginnie Mae", a government corporation that broke off from Fannie Mae) – issued 98% of the $1.4 trillion in mortgage-backed securities in the United States so far in 2013. These securities are sold in order to add liquidity to the mortgage market, thereby making funds available to borrowers.

"If Fannie and Freddie go away, what then happens to the mortgage markets?" asks Bove. "The answer to that question is that we no longer have things like 20-year and 30-year mortgages because banks are not going to put that type of mortgage on their balance sheets. And we won't have fixed-rate mortgages."

Bove says the banks he spoke with won't be able to provide 30-year mortgages in large quantities without Fannie Mae and Freddie Mac in the markets. "I've called a number of very large banks – the largest issuers of mortgages in the United States – and asked them, 'If there was no Fannie and Freddie, what would be the typical mortgage in the United States?' And, the answer is a 10- to 15-year adjustable rate mortgage."

The end of Fannie Mae and Freddie Mac is a major sea-change in how the government views affordable housing, according to Bove.

"It is no longer the goal of the United States government that every household should have its own home," say Bove. "In my view, that's a call for a return of public housing and all of the ills that went with public housing."

Affordable Housing Nonsense

The results of "affordable housing" programs speak for themselves.

In the last decade, hundreds of "affordable housing" programs at the federal and state level did anything but make housing affordable.

Together with president George Bush's inane "ownership society", the price of homes skyrocketed, as did taxes on homes. And cities did not use those tax dollars very wisely, did they?

Low interest rates, declining lending standards, ownership promotion mentality, 95% mortgages, and a host of other silly ideas fueled the biggest housing bubble in history.

Then when housing prices crashed,  the Fed  and government bureaucracies at every level (city, state, federal) acted in unison, hoping to force home prices back up.

So spare me the sap about "affordable homes". Neither the Fed nor government bureaucrats really want "affordable housing".

I highly doubt Dick Bove does either. But if by some miracle he does, he sure as hell does not know the best way to achieve that goal.

Oh The Horror

Bove laments "If there was no Fannie and Freddie, what would be the typical mortgage in the United States?' And, the answer is a 10- to 15-year adjustable rate mortgage."

If Bove is correct, that would be a great thing! People would not over-leverage, prices would be stable, and at the end of 10 years people would actually "own" something.

California Commercial Banker Chimes In

A California Banker friend (ACB) sent me the above link and also chimed in with his thoughts.

Hi Mish

I’m sure you’ve written before about closing down Fannie and Freddie. I too support the idea. In essence, we should return lending to the free market. The government sponsored lending boom via GSEs, together with cheap money from the Fed and declining lending standards, led to artificially high real estate values culminating in various bubbles.

Bove’s research with bank executives leads to the conclusion that all mortgages in the future will be 10-15 year loans on variable rates. I find that odd, because I’ve been a Commercial Banker for 20 years, we write variable rate commercial real estate loans on a 25 year amortization due in 5, 7 or 10 years all the time.

I do agree that most mortgages will be variable/adjustable, as a bank you just can’t take the interest rate risk by offering longer term fixed rates if you hold those loans on your balance sheet.

Another possibility would be something along the lines of bonds (not government backed) to support some fixed rate lending. The underwriting criteria behind these loans might be and should be stronger, say a minimum 25-30% equity, 28% front end debt/income ratio, prudent back end ratios, upper tier credit history, and strong job history. In essence, left to its own accord, the market would rid itself of the flimsy underwriting under the old Freddie and Fannie model.

Then, if Freddie and Fannie went away, wouldn’t major banks who write most of the mortgage loans have to pay a little better interest rate on certificate of deposits (benefiting seniors) to attract capital into the banks to make mortgage loans?

We’ve become so government dependent, we fail to understand the free market will solve the alleged mortgage problem quite easily.

Lending should be a prudent thing, not a government sponsored free-for-all for political purposes.

Thanks,
California Banker

Bingo.

ACB and I welcome a return to lending sanity and an end to boom-bust cycles sponsored by the Fed and government bureaucrats.

Bove believes government can and should promote "affordable housing" even though history (and common sense) suggest the idea is ridiculous.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

J.P. Morgan Reaches $13 Billion Deal with Justice Department; Is This a Fair Deal?

The Wall Street Journal reported today J.P. Morgan Reaches $13 Billion Tentative Deal with Justice Department. However a criminal investigation is not yet closed.

J.P. Morgan Chase & Co. has reached a tentative deal to pay a record $13 billion to the Justice Department to settle a number of outstanding probes of its residential mortgage-backed securities business, according to a person familiar with the decision.

The deal, which was struck Friday night, doesn’t resolve a continuing criminal probe of the bank’s conduct, which could result in charges against individuals or the bank itself and possibly increase the penalty tab. The two sides continued to disagree over an admission of wrongdoing that would end the criminal probe and decided instead to resolve the civil allegations related to the mortgage securities.

The deal includes $4 billion to settle claims by the Federal Housing Finance Agency that J.P. Morgan misled Fannie Mae and Freddie Mac about the quality of loans it sold them in the run-up to the 2008 financial crisis, another $4 billion in consumer relief, and $5 billion in penalties paid by the bank, according to a second person close to the talks. How the consumer relief and penalties get dispersed and distributed is largely up to the government, and those details are still unclear, this person said.

The tentative settlement comes as J.P. Morgan tries to put as many legal woes behind it as possible. Earlier this week, J.P. Morgan agreed to pay $100 million and acknowledge wrongdoing to settle allegations by the Commodity Futures Trading Commission related to its botched “London whale” trades. Last month, the bank agreed to pay $920 million to settle similar charges with U.S. and U.K. regulators related to that 2012 trade.

The task force issued a series of subpoenas to various financial companies, seeking internal documents. Those documents held a number of promising leads, one of which was assigned to federal prosecutors in Sacramento.

Investigators in that case discovered an email by a bank employee, warning her higher-ups that the bank was vastly overstating the value of the mortgages being securitized, according to people familiar with the probe. That employee, who has since left the company, has been cooperating with federal prosecutors, who expect to call her as a witness if the case ever goes to trial, according to people familiar with the case.

While the Justice Department considers the evidence in that case to be strong, officials at the bank strongly disagree, according to people familiar with the negotiations.

In late September, as the Justice Department neared its own deadline to file a civil lawsuit in the case, the bank offered $3 billion to settle the case. Attorney General Eric Holder rejected that offer, and government lawyers prepared to file the suit. The bank then offered billions more, if the government was willing to throw into the settlement separate cases, raising the total price and resolving more of the bank’s legal headaches.

As the negotiations intensified in September, Mr. Dimon sought a face-to-face meeting with Mr. Holder to try to resolve the remaining sticking points. The two met Sept. 26 at the Justice Department, but the meeting failed to settle the outstanding issues. As talks continued over the remaining weeks, the size of the deal swelled, but the two sides continued to disagree over an admission of wrongdoing that would end the criminal probe.

On Friday night, Mr. Dimon and Mr. Holder decided they were just not going to come to terms on the criminal issue–and take the deal on the terms where they did agree.

Is This a Fair Deal?

For starters, I am astonished at the massive settlement. $13 billion sounds huge (and it is compared to the typical whitewashing affairs we see).

However, things could have been much worse.

CNN Money notes JPM held "$23 billion in reserves for potential litigation expenses. In a footnote to its SEC filing, the bank said legal costs could be nearly $6 billion above that figure in a worst case scenario."

Perhaps $23 billion, $40 billion, or any amount that wipes out JP Morgan litigation reserves is "fair".

Clearly "fair" is in the eyes of the beholder. I will consider it "fair" if executives of the largest banks are tried and convicted in criminal court. Don't count on it. As astonished as I was about the amount of the settlement, I will be even more astonished if any bank executives are criminally convicted.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

Future of Education is At Hand: Online, Accredited, Affordable, Useful

I have long been in the camp that the price of education is so expensive as to make college a poor choice for many who attend, and a downright bad choice for those who go heavily in debt for degrees in little demand.

The entire education system is and has been for some time unsustainable. The cost of education keeps rising along with ...

1. Government aid
2. Union contracts
3. Pension benefits
4. Salaries of coaches
5. Competition for the most elaborate dorms
6. Fundraising

Dylan Matthews at the Washington Post has a 10-part series called "The Tuition is Too Damn High". The first seven articles in the series are already available. Part-10 is the writer's proposed solution.

I have talked about most of the points above except point five. Matthews discusses "dorm competition" in Part VI — Why there’s no reason for big universities to rein in spending.

Freddie de Boer is a grad student at Purdue University, one of Indiana’s flagship public research institutions. Purdue has a new gym – excuse me, a new “sports center,” the France A. Córdova Recreational Sports Center, to be exact. When de Boer went to check it out, he found treadmills that each featured a TV and an iPod dock, a bouldering wall and a 55-foot climbing wall, a spa with Jacuzzi function that can fit 26 people, six racquetball courts, and a “demonstration kitchen” for cooking lessons.

The Córdova Center wasn’t an expense that needed to be paid for. It was an expense made because it could be made, because the nonprofit university rewards those who spend money, not those who save it.

I suggest the problem with the education system is largely that of government throwing more money at the problem. Just as hundreds of affordable housing programs raised (not lowered the price of homes), the same happened in the education system.

Throw in union graft, pensions, sports, and you have the problem in a nutshell. The solution is simple.

Three-Part Solutions

1. Stop all student aid programs
2. Increase competition via accredited online programs
3. End the preposterous pension plans of educators and administrators

Of my three proposals, number two above is now at hand, in the form of more accredited online education, at reputable institutions, giving advanced degrees at affordable prices.

The MOOC That Roared

Reader "Tom" pinged me today with this email:

Hi Mish,

I've read your thoughts and comments on higher education and the future of college degrees. I agree with most of your ideas, but I would have guessed we were 5-10 years away from some of that stuff. Nope. Georgia Tech has a Master's in Computer Science that is going to bust higher education wide open. Check it out:

Maybe I'll get that PhD after all.

Best.... Tom

Radical Change

Tom sent a link to a Slate article The MOOC That Roared, subtitled "How Georgia Tech’s new, super-cheap online master’s degree could radically change American higher education".

Georgia Institute of Technology is about to take a step that could set off a broad disruption in higher education: It’s offering a new master’s degree in computer science, delivered through a series of massive open online courses, or MOOCs, for $6,600.

The school’s traditional on-campus computer science master’s degree costs about $45,000 in tuition alone for out-of-state students (the majority) and $21,000 for Georgia residents. But in a few years, Georgia Tech believes that thousands of students from all over the world will enroll in the new program.

The $6,600 master’s degree marks an attempt to realize the tantalizing promise of the MOOC movement: a great education, scaled up to the point where it can be delivered for a rock-bottom price. Until now, the nation’s top universities have adopted a polite but distant approach toward MOOCs. The likes of Yale, Harvard, and Stanford have put many of their classes online for anyone to take, and for free. But there is no degree to be had, even for those who ace the courses.

George Washington University’s online MBA Healthcare degree, for example, costs the same $1,485 per unit (52.5 units gets you to the finish line) as the standard program. The reasons for this are many, but perhaps the most important is that universities are terrified of debasing the value of their diplomas.

Drop the price of the online degree, the logic goes, and you could have a Napster-like moment sweeping college campuses. Revenues spiral down as degree programs are forced to compete on tuition. That’s a terrifying prospect for universities, which have depended on steadily rising tuition—growing at more than twice the rate of inflation—to cover costs.

Georgia Tech’s new program, though, throws a monkey wrench into the system by reordering the competitive landscape. U.S. News & World Report ranks the computer science department among the nation’s top 10. The new degree—which is a partnership with MOOC pioneer Udacity—is intended to carry the same weight and prestige as the one it awards students in its regular on-campus program.

Uncharted Territory

Someone at Georgia Tech is thinking, and that person is Zvi Galil, the head of Georgia Tech’s school of computing.

"This is uncharted territory," he says. But, he warns, if Georgia Tech doesn’t do this someone else might come along and do it first—grabbing the notoriety, the students, and the revenue. "There is a revolution. I want to lead it, not follow it".

As I have stated repeatedly, someone was bound to do this, and here we are. And it will not stop with advanced degrees, but rather spread like wildfire to lower degrees.

I have warned parents with kids in grade school to not lock in education costs at today's rates because I expected costs to come down. And they will, dramatically, within a few years.

Unfortunately, this will not do much for high school seniors right now. And it certainly will not do anything for those buried in student debt with no job and no way to pay it back.

But relief is coming for those still in grade school.

Welcome Deflationary Event

College dorms will be for kids of the wealthy, but even then, expect costs to mitigate somewhat when parents decide there is no extra "value" in spending an additional $40,000 a year for education.

Yes, this is a deflationary event, and one that everyone will welcome (except those who benefit from the current system of waste and graft).

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

Mortgage REITs Clobbered as Leverage Forces Sales

Curve Watchers Anonymous continues to follow the rise in treasury yields. Here are a couple of charts.

$TNX: 10-Year Treasury Yield



Yield on the 10-year note has risen from 1.614% to 2.664% since the beginning of May. The following chart provides a better historical perspective.

Yield Curve As Of 2013-07-20



click on chart for sharper image

• $TYX 30-Year Treasury Bond Yield: Green
• $TNX 10-Year Treasury Note Yield: Orange
• $FVX 05-Year Treasury Note Yield: Blue
• $IRX 03-Month Treasury Bill Discount Rate: Brown

The rise in yields have wreaked havoc in the bond markets and even more so in mortgage-related Real Estate Investment Trusts (REITs).

REITs Deepening Bond Losses as Leverage Forces Sales

Bloomberg reports REITs Deepening Bond Losses as Leverage Forces Sales

Annaly Capital Management Inc. (NLY)’s Wellington Denahan, head of the largest mortgage real-estate investment trust, told investors less than three months ago that reports REITs could threaten U.S. financial stability were as misleading as the media frenzy over shark attacks in 2001.

Since the May 2 comments, shares of the companies, which use borrowed money to make $400 billion in credit market bets, dropped about 19 percent through yesterday and the value of their assets has plunged after the Federal Reserve triggered a flight from bond funds by signaling plans to slow its debt-buying program.

REITs may have needed to sell about $30 billion of government-backed mortgage securities in just one week last month to maintain the amount of borrowing relative to their net worth, according to JPMorgan Chase & Co. Those types of sales deepened losses in the mortgage-bond market, which had the worst quarter since 1994, accelerated the exit from fixed-income funds and fueled a jump in home-loan rates to a two-year high.

Mortgage rates jumped to 4.46 percent at the end of June, up from a near-record low of 3.35 percent in early May, after the central bank indicated it will taper its monthly debt buying, including $40 billion of government-backed housing debt.

Firms including Annaly, American Capital Agency Corp. (AGNC), the second biggest of the companies, and Armour Residential REIT Inc. (ARR), sell shares to the public so the capital can’t be redeemed. They also rely on leverage, typically using about six to eight times the amount of borrowed money compared with their capital.

That means they benefited from cheap financing as the Fed kept short-term interest rates near zero for more than four years. REITs more than tripled holdings of government-backed home-loan bonds since 2009 and their increased buying power helped push down mortgage rates.

Leverage Sharks Bite

Bloomberg reports "Annaly’s Denahan presented her shark analogy after Fed Governor Jeremy Stein referenced mortgage REITs in a February speech on how credit markets were showing signs of potentially excessive risk-taking."

Mortgage REITs Stumble

Morningstar reports No Surprises Here: Mortgage REITs Stumble

Mortgage REITs are a polarizing asset, either loved (for their yield) or despised (for their risk) by investors. The bears must be feeling vindicated now, as the market's emotional response to the Fed's recent announcements sent iShares Mortgage Real Estate Capped (REM) into a nosedive since the beginning of April. REM lost a stomach-churning 19% over the past three months, driven by instability in the yield curve and falling book values.

Not to be confused with equity REITs, which generate income by managing properties and collecting rent, mortgage REITs are financial firms that arbitrage the spread between the short-term interest rate and income from mortgage-backed securities. Mortgage REITs do not have access to deposit funding, so they rely on short-term loans like repurchase agreements. The largest firms purchase federally guaranteed securities from Freddie Mac and Fannie Mae.

Mortgage REITs are very susceptible to the risk of rising short-term rates. Until recently, mortgage REITs have benefited from the Fed's easy money policy. The Fed's historically low near-zero interest rate makes financing cheap, allowing mortgage REITs to use leverage to provide an attractive yield. However, because these firms are so extensively leveraged, they are very susceptible to interest-rate fluctuations. The majority of mortgage REIT financing is as short term as 30 days, so if the capital markets freeze, these firms could be forced to accept unfavorable terms. Lenders also can make margin calls following a market decline. Either situation could force mortgage REITs to raise capital through share issuance.

Historical evidence is not encouraging: Mortgage REITs cut their distributions and performed poorly during past rising rate environments. REM's two major holdings, Annaly Capital Management (NLY) (17.5% of assets) and American Capital Agency (AGNC) (13%), unsurprisingly cut their distributions even further in June after continued sell-offs. Both companies reduced their dividends last year as well. Because REM's distributions (which are more volatile than payouts from equity REITs or the broad market) account for as much as 80% of the fund's total return, declines in payouts considerably reduce return.

REM Daily Chart - Mortgage REITs



Investors and hedge funds plowed into REITs believing treasury and mortgage rates would stay low forever. And they are still low historically. But if the secular low in treasury and mortgage yields is in, these kind of losses will accumulate.

Leverage runs both ways.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

FHA Swamped By Defaults; Congressional Report Shows FHA Could Suffer Losses as High as $115 Billion; Shut Down Fannie, Freddie, FHA

An alleged "worst case scenario" shows the FHA could lose as much as $115 Billion. Since these worst case scenarios are always famously optimistic, the best course of action would be to shut the agency down.

I was quoted as saying just that by the Heartland in Congressional Report Raises Spectre of FHA Bailout.

The Federal Housing Administration's (FHA) losses over the next 30 years could be much higher than originally projected, according to the findings of a congressional committee. The dismal forecast has some bracing for another taxpayer-financed bailout.

The House Oversight and Government Reform Committee, chaired by Rep. Darrell Issa (R-Calif.) is reporting that a worst-case scenario stress test conducted last year estimated the FHA could suffer losses as high as $115 billion. That forecast is significantly worse than the one reported by independent auditor Integrated Financial Engineering Inc., which projected losses of $65 billion for the 79-year old agency.

Swamped by Defaults

The primary cause of the FHA's troubles is the plague of underwater mortgages that has struck the housing sector in recent years. During the late housing bubble, the FHA lost market share as more private lenders sold “subprime” loans to home buyers. But with the collapse of the housing market in 2007-08, much of that business returned to the FHA. While the agency has played a major role in propping up home prices, it has also been overwhelmed by defaults.

John Ligon, senior policy analyst at the conservative Heritage Foundation, writes:

The FHA has a core mission of providing targeted support to creditworthy low- and moderate-income, minority, and first-time homebuyers. The FHA cannot responsibly achieve these intended objectives when it is expanding its market share and competing with the conventional market for high-cost mortgage loans.

According to Ligon, the only way the FHA can avoid a bailout is to reduce its market share by lowering maximum loan limits to $325,000 over the next four years, raise credit requirements for borrowers, and institute “burden sharing” with loan originators by reducing insurance coverage from the current 100 percent to 50 percent by 2016.

While these reforms may improve FHA's balance sheet over the long term, they would also reduce market liquidity, which in turn could cause home prices to fall. Thus homeowners with little home equity now could find themselves underwater on their mortgages, which could trigger more defaults.

But it is precisely this apparent dilemma that government-sponsored enterprises like FHA have created with their meddling into the market that has some calling for a more radical approach.

‘Shut Down Fannie, Freddie, FHA’

“I would shut down Fannie Mae, Freddie Mac, the FHA, HUD, and such similar programs and agencies,” says Mike “Mish” Shedlock, a market analyst and host of the Web site Mish's Global Economic Trend Analysis. “The more money government threw at housing, the less affordable housing became until the bubble popped.”

He says numerous government agencies and programs “should be shut down and things would be far better off because government can never allocate money better than the free market.”

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

Fools Never Learn

Proving that fools never learn, the Obama administration pushes banks to make home loans to people with weaker credit

President Obama’s economic advisers and outside experts say the nation’s much-celebrated housing rebound is leaving too many people behind, including young people looking to buy their first homes and individuals with credit records weakened by the recession.

In response, administration officials say they are working to get banks to lend to a wider range of borrowers by taking advantage of taxpayer-backed programs — including those offered by the Federal Housing Administration — that insure home loans against default.

Housing officials are urging the Justice Department to provide assurances to banks, which have become increasingly cautious, that they will not face legal or financial recriminations if they make loans to riskier borrowers who meet government standards but later default.

Officials are also encouraging lenders to use more subjective judgment in determining whether to offer a loan and are seeking to make it easier for people who owe more than their properties are worth to refinance at today’s low interest rates, among other steps.

Here We Go Again

Mark Hanna commented "And Here We Go Again"

Indeed. Home markets are booming again so let's get everyone in on it.
The whiners are piling on already.

“If you were going to tell people in low-income and moderate-income communities and communities of color there was a housing recovery, they would look at you as if you had two heads,” said John Taylor, president of the National Community Reinvestment Coalition, a nonprofit housing organization. “It is very difficult for people of low and moderate incomes to refinance or buy homes.”

The FHA, in coordination with the White House, is working to develop new policies to make clear to banks that they will not lose their guarantees or face other legal action if loans that conform to the program’s standards later default. Officials hope the FHA’s actions will then spur Fannie and Freddie to do the same.

The effort requires sign-on by the Justice Department and the inspector general of Department of Housing and Urban Development, agencies that investigate wrongdoing in mortgage lending.

Proven Results

We tried this already. The results were not pretty, to say the least.

In spite of all the huffing and puffing by this administration, no one went to jail. Heck, no one was even prosecuted.

And now, after whining for more bank regulations, the White House wants even looser lending standards. Let's lower our standards so everyone qualifies for a loan. Again! And while we're at it, let's make the banks immune from prosecution! Then let's put taxpayers at risk via "taxpayer-backed programs" for the whole boondoggle.

This is all so obviously stupid that only a fool could propose it.

And a fool in the highest spot did just that.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

Polls Shows American Believe There is Too Much Government Regulation; Government Regulation a Leading Cause of the Housing Bubble

Gallup Polls show Little Appetite in U.S. for More Gov't Regulation of Business

Americans say there is too much (47%) rather than too little (26%) government regulation of business and industry, with 24% saying the amount of regulation is about right. Americans have been most likely to say there is too much regulation of business over the last several years, but prior to 2006, Americans' views on the issue of government regulation of business were more mixed.

Question: In general, do you think there is too much, too little, or about the right amount of government regulation of business and industry?



The collapse of Lehman Bros., the failure of the secondary mortgage market, and other business problems in 2008 and 2009 might have been expected to increase Americans' desire for more government control of business and industry. But that was not the case. Americans' views that there is too much government regulation in fact began to rise in 2009, perhaps in response to the new Obama administration and new business regulation policies such as Dodd-Frank, reaching an all-time high of 50% in 2011 before settling down slightly this year to 47%.

There has been little change since 2003 in the percentage of Americans saying there is too little regulation of business. The changes that have occurred in recent years have involved shifts between the percentages choosing the "too much" and "about right" alternatives.

The polls look a lot different if you break down the results by political party.

• 77% of Republicans say there is too much regulation and only 9% think there is too little.
• 46% of independents think there is too much regulation, and 24% too little.
• 25% of democrats think there is too much regulation, and a whopping 42% think there is too little.

Cause of the Financial Collapse

The Democrats are simply wrong. One of the reasons we are in this mess is because of too much regulation. Here several examples.

1. President Kennedy allowed forced collective bargaining of public unions which eventually drove cities and states to fiscal ruin.
2. The Fed micromanages interest rates and that was a huge factor in creating the housing bubble. Note the Fed was created as a result of government regulation.
3. Congress had hundreds of affordable housing programs including Fannie Mae and Freddie Mac. Affordable housing programs and lending mandates such as the Community Reinvestment Act also contributed to the housing bubble
4. The SEC anointed Moody's, Fitch, and the S&P as "Nationally Recognized Statistical Rating Organization (NRSRO)". Once again this regulation came back to bite years later when  the ratings agencies labeled pure garbage as "AAA"

Time To Break Up The Credit Rating Cartel

Let's take a closer look at point number four. I discussed the ratings agencies in depth in Time To Break Up The Credit Rating Cartel

The rating agencies were originally research firms. They were paid by those looking to buy bonds or make loans to a company. If a rating company did poorly it lost business. If it did poorly too often it went out of business.

Low and behold the SEC came along in 1975 and ruined a perfectly viable business construct by mandating that debt be rated by a Nationally Recognized Statistical Rating Organization (NRSRO). It originally named seven such rating companies but the number fluctuated between 5 and 7 over the years.

Establishment of the NRSRO did three things (all bad):

1) It made it extremely difficult to become "nationally recognized" as a rating agency when all debt had to be rated by someone who was already nationally recognized.
2) In effect it created a nice monopoly for those in the designated group.
3) It turned upside down the model of who had to pay. Previously debt buyers would go to the ratings companies to know what they were buying. The new model was issuers of debt had to pay to get it rated or they couldn't sell it. Of course this led to shopping around to see who would give the debt the highest rating.

With that I have to sit back and laugh at one of the original opening statements in this article: "I do not think that the market can discipline ratings agencies sufficiently," said Mr Mindich, chief executive of Eton Park Capital and a former colleague of Hank Paulson, the Treasury secretary, at Goldman Sachs, the investment bank.

Clearly Mr. Mindich does not understand the free market. The problems arose because the free market was disrupted by a misguided mandate by the SEC.

The Solution is Amazingly Easy

Government sponsorship of organizations and intervention into free markets always creates these kinds of problems. The cure is not an executive shuffle, third party verification or half-measures and more regulation that mask over the issues by splitting functions within an organization. The SEC created this problem by creating the NRSRO. The problem is easily fixable. It's time to break up the cartel by eliminating the rules that created it. Moody's, Fitch, and the S&P should have to sink or swim by the accuracy of their ratings just like everyone else. Ratings would be a lot better if corporations had to live or die by them. Free market competition, not additional regulation is the cure.

Government Regulation a Leading Cause of the Housing Bubble

Many point to elimination of Glass-Stagall as the cause of the crisis. They are wrong. Glass-Steagall would not have stopped the securitizion process or passing the trash to Fannie Mae or investors. It would not have stopped the AAA rating scam of Moody's, Fitch, and the S&P.

A case can be made for Glass-Steagall on the grounds that separation of duties wouls prevent fraud, and regulations designed to preserve property rights and prevent fraud are reasonable. However, Glass-Steagall would have done nothing to stop the housing bubble or subsequent crash.

The key point is government regulation, the Fed, and fractional reserve lending are the primary causes of numerous boom-bust cycles.

Regulation should focus on fraud prevention and preservation of property rights, not misguided social agenda like "affordable housing". Government never makes anything affordable.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Still More on Credit-Worthiness of Bank Lending in Housing Bubble: Loan Originations vs. True Bank Lending

In response to Reader Questions on "Credit-Worthiness": Did Banks Give Mortgages to Non-Creditworthy Borrowers? I received an email from reader David, who wanted to expand on point number 5 below from my post.

This is what I stated, adding the words [banks thought]. The email from reader David follows this recap.

Five Reasons Banks Extended Credit in Housing Bubble Years

1. [Banks thought] People would pay mortgage loans because they always did
2. [Banks thought] Housing prices would rise sufficiently to cover defaults
3. [Banks thought] Mortgage interest rates to subprime borrowers were high enough to cover risk
4. [Banks thought] Defaults would happen over a long period of time, not quickly concentrated
5. Banks could pass the trash to Fannie Mae and Freddie Mac (without clawbacks for non-performance), and/or loans could be sliced and diced in tranches to investors

If any of those conditions were true, then banks were indeed making loans to "credit-worthy" borrowers. Subprime borrowers did pay a huge penalty rate. Multiple combinations of the above five points are likely.

Huge Mistakes Coupled With Greed

Banks made huge mistakes because all five conditions above failed, far sooner than banks or the Fed expected. Recall that Bernanke did not believe there was a housing bubble at all!

Thus, at the time, banks thought they were making creditworthy loans.

They thought wrong, in a big way, and they were very greedy as well. Greed coupled with poor thinking is a very bad combination.

What About Now?

Banks are not lending now for three reasons

1. Banks are capital impaired
2. Banks are worried about being repaid
3. The relatively small pool of credit-worthy borrowers who banks would lend to right now, do not want credit

Stunning Change in Attitudes

Another way of looking at the five points pertaining to the "housing bubble years" is there has been a stunning change in attitudes regarding how banks perceive "credit-worthiness" as well as a stunning change in willingness of consumers to go deeper in debt.

Conclusion: Then as now, banks only lend to customers they think are credit-worthy.

However, Attitudes on what it takes to be "credit-worthy" have changed.

Attitudes are the key to understanding this apparent conundrum.

Email Regarding Point Number Five

Reader David wants to emphasize point number five ...

Hello Mish

Please emphasize that in the mortgage bubble, banks did not lend for the most part, they originated. Thus creditworthiness was not a factor since the agents who would face most of the losses were not banks, they were instead Fannie/Freddie, investors of MBS paper and especially investors of structured MBS paper and CDO's.

The banks themselves only held inventory of super-senior paper which they expected had enough cushion to absorb any losses. Moreover, the banks held this paper off-balance sheet in SIV's and other conduits which technically were separate from the bank.

Thus the loan-origination process asked not whether the borrower was credit-worthy, it asked only whether that loan could be sold on for a profit.

David is clearly correct.

So I wish to reiterate ... If banks think they will make enough profit to compensate for the risks they take, then they make loans.

If they think they will make adequate profit on the loans, then by definition, they think they are making credit-worthy loans.

Of course, as I pointed out, what banks thought would happen and what actually happened are two different things. Regardless of what did happen, banks thought they were making credit-worthy loans.

Banks did originate tons of garbage (on purpose), but only with the intent to immediately pass the trash, not to hold the loan. The distinction is extremely important.

Recall this discussion of "credit-worthy" lending is but a subpoint in the discussion of my original post regarding bank reserves: Can Bernanke Force Banks to Lend by Halting Interest on Excess Reserves?.

Regardless of any discussion of credit-worthy lending, the answer is still the same: Bernanke cannot force banks to lend by lowering interest on excess reserves to zero.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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