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Thursday, March 06, 2008 2:12 PM

Financial System Broken - Markets 'Utterly Unhinged'

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Bloomberg is reporting Mortgage Markets 'Utterly Unhinged'

Yields on agency mortgage-backed securities rose to their highest relative to U.S. Treasuries in 22 years as banks stepped up margin calls and concerns grew that the Federal Reserve may be unable to curb the credit slump.

The difference in yields, or spread, on the Bloomberg index for Fannie Mae's current-coupon, 30-year fixed-rate mortgage bonds and 10-year government notes widened about 7 basis points, to 223 basis points, the highest since 1986 and 89 basis points higher than Jan. 15. The spread helps determine the interest rate homeowners pay on new prime mortgages of $417,000 or less.

The markets have become "utterly unhinged," William O'Donnell, a UBS AG government bond strategist in Stamford, Connecticut, wrote in a note to clients today. A lack of liquidity has "led to stunning air-pockets in price levels."

"Everything is telling you the financial system is broken," Simon, whose Newport Beach, California-based unit of Allianz SE manages the world's largest bond fund, said in a telephone interview today. "Everybody's in de-levering mode."

The widening spreads prompted speculation the government may step in to support securities guaranteed by Fannie Mae and Freddie Mac, said Tom di Galoma, head of U.S. Treasury trading in New York at Jefferies & Co., a brokerage for institutional investors. The Treasury Department said the rumor isn't true.

"The Fed can't really save the mortgage market," di Galoma said. "As they keep cutting, mortgage rates aren't going lower."
Let's take a look at the systemic rot that shows how and why the financial system is broken causing the markets to become unhinged.

Home Foreclosures Hit Record High

Yahoo Finance is reporting Industry Group Says Home Foreclosures at Record High Last Quarter.
The Mortgage Bankers Association, in a quarterly snapshot of the mortgage market released Thursday, said the proportion of all mortgages nationwide that fell into foreclosure shot up to a record high of 0.83 percent in the October-to-December quarter. That surpassed the previous high of 0.78 percent set in the prior quarter.

"Clearly it's the worst it's been," chief association economist Doug Duncan said in an interview with The Associated Press.

The delinquency rate for all mortgages climbed to 5.82 percent in the fourth quarter. That was up from the 5.59 percent in the third quarter and was the highest since 1985. Payments are considered delinquent if they are 30 or more days past due.

Homeowners with tarnished credit who have subprime adjustable-rate loans were the hardest hit. Foreclosures and late payments for these borrowers also swelled to all-time highs in the fourth quarter.

The percentage of subprime adjustable-rate mortgages that entered the foreclosure process soared to a record of 5.29 percent in the fourth quarter. That was up from 4.72 percent in the prior quarter, which had marked the previous high. Late payments skyrocketed to a record high of 20.02 percent in the fourth quarter, up from 18.81 percent -- the previous high -- in the third quarter.
Homeowner Equity Is Lowest Since 1945

The federal reserve report shows Homeowner Equity Dipping Below 50 Percent, the Lowest on Record.
Americans' percentage of equity in their homes fell below 50 percent for the first time on record since 1945, the Federal Reserve said Thursday. Homeowners' portion of equity slipped to downwardly revised 49.6 percent in the second quarter of 2007, the central bank reported in its quarterly U.S. Flow of Funds Accounts, and declined further to 47.9 percent in the fourth quarter -- the third straight quarter it was under 50 percent.

That marks the first time homeowners' debt on their houses exceeds their equity since the Fed started tracking the data in 1945. The total value of equity also fell for the third straight quarter to $9.65 trillion from a downwardly revised $9.93 trillion in the third quarter.

Moody's Economy.com estimates that 8.8 million homeowners, or about 10.3 percent of homes, will have zero or negative equity by the end of the month. Even more disturbing, about 13.8 million households, or 15.9 percent, will be "upside down" if prices fall 20 percent from their peak.

The latest Standard & Poor's/Case-Shiller index showed U.S. home prices plunging 8.9 percent in the final quarter of 2007 compared with a year ago, the steepest decline in the 20-year history of the index.
Owners Give Up

According to the Mortgage Bankers Association, Homeowners are giving up, walking away.
"We're seeing people give up even before they get to the reset because they couldn't afford the home in the first place," said Jay Brinkmann, vice president of research and economics for the Washington-based trade group.

"It comes down to an overstretching of buyers to get into homes they couldn't afford and an overextending of credit by lenders who were more willing to take risk," Brinkmann said.

Freddie Mac and Fannie Mae, the biggest U.S. mortgage finance companies, have posted their largest-ever losses as rising defaults boosted credit costs. Fannie Mae had a $3.55 billion loss in the fourth quarter, the Washington-based company said Feb. 27. Freddie Mac reported $2.45 billion fourth-quarter loss the following day.
Overleveraged Hedge Funds Are Blowing up

Hedge funds using 32 times leverage made bad nets on mortgage backed securities. Carlyle Capital Was Hit With Margin Calls And Default Notices.
Carlyle Capital Corp., a listed investment company managed by a unit of private-equity firm the Carlyle Group, added to worries about forced liquidations of residential mortgage-backed securities after failing to meet margin calls on its $21.7 billion portfolio Wednesday.
The worst Is Yet To Come

The Mortgage crisis is deepening. Rates on 1.5M home loans will reset this year.
The mortgage crisis seems to have no end and no solution, but that isn't stopping Ben Bernanke from trying.

Tuesday the Federal Reserve Chairman floated the idea that banks and investors should write off part of the loan principal for homeowners who find themselves owing more on their mortgages than their homes are worth.

"Although lenders and servicers have scaled up their efforts and adopted a wider variety of loss-mitigation techniques, more can, and should, be done," Bernanke told a meeting of the Independent Community Bankers of America. "Principal reductions that restore some equity for the homeowner may be a relatively more effective means of avoiding delinquency and foreclosure."

The idea was an instant dud with mortgage lenders, who say they already have big incentives to keep borrowers from defaulting. Wiping out some of the principal owed on homes would increase mortgage rates to all borrowers, they say, and could encourage more homeowners to default on loans to get lower payments.

Harry Glanz, co-founder of Capital Mortgage Funding in Southfield, says Bernanke's idea would do more harm than good.

"How is that going to happen without the next-door neighbor asking for the same thing?" Glanz asked. "It sounds good but, in all practicality, how are you going to put it into practice?"
Mortgage Market Action Explained

If you were by any chance wondering why mortgage rates were not following the Fed's slash and burn policy of lower rates, the long answer is above. The short answer is rising default risk.

But let's not be too gloomy here.

Other than overleverage, bad debts, sinking home prices, no jobs, shrinking wages, cash strapped US consumers, rising oil prices, a sinking US dollar, $500 trillion in derivatives not marked to market, rampant overcapacity, underfunded pension plans, looming boomer retirements, no funding for Medicaid, no funding for Medicare, and no Social Security trust fund, everything is just fine.

And even though the Fed, central bankers in general, and governments combined to create this problem, the irony is nearly everyone is begging for them to fix the problem by encouraging still more speculation in housing, commercial real estate, and the markets.

Sorry folks, it's the end of the line and payback time for the world's most reckless financial experiment in history. The deflation genie can't be put back in the bottle until leverage everywhere is unwound.

Mike "Mish" Shedlock
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